Annual Revenue Run Rate
The annual revenue run rate (ARR) is the annual rendition of monthly recurring revenue or MRR. Based on current monthly revenue, ARR helps you to estimate the future revenue of your company or firm for a year. When calculating ARR, it is assumed that nothing changes in your SaaS metrics. MRR, churn, and customer count will remain the same.
It may appear unrealistic in practice, but the annual revenue run rate (ARR) is a very helpful metric to predict the long-term growth of your business and visualize the actual size of your business. If you hear someone saying they are a $1M business, it means they are referring to their ARR. In simple words, this year, they are going to bring $1M in recurring revenue at the current rate.
ARR can easily be calculated based on your company’s MRR. You just have to find out MRR and multiply it by 12 to get ARR. For example, if your MRR for the previous month is $100K then your ARR will be $1.2M.
Foremost Issue With ARR
The biggest problem with estimating ARR by multiplying MRR by 12 is the fluctuations in month-to-month sales. For example, if you are running a seasonal business, you can estimate a very high ARR during busy months. The same happens when you get a big customer in a month and calculate ARR based on this month’s recurring revenue.
To smooth out these month-to-month fluctuations, some companies can opt for calculating ARR on a quarterly MRR basis. In simple words, these companies multiply the recurring revenue from a quarter by four. Rather than looking at just one number for the annual run rate, it’s noteworthy to look at the trends over time to see the growth of a company.
How to Estimate ARR?
ARR can be calculated by using the accrual accounting method. Accrual accounting is a method that recognizes every economic event separately from when the cash is collected. It’s based on the matching of the earnings and expenditures in the month where they occur in actuality. For example, if you signed a subscription on an annual basis, you will get 1/12th value of this subscription every month. In simple words, you cannot invoice for the revenue until you provide the service. This method provides a very realistic picture of month to month progress of your business.
Just like MRR, ARR is also calculated on earned revenue. You cannot account for the whole ARR in the month you sold the subscription. Similarly, you cannot add off payments as well in this calculation as they are not expected recurring income.
ARR and MRR Correlates
ARR is very similar to MRR. In fact, ARR is just a multiplier of MRR. Knowing MRR in detail can help you estimate and improve ARR as well.
