The King of SaaS Metrics: What is ARR and Why Does it Matter?

As a startup it's a good practice to keep track of your one or two most important metrics. If you have a Software as a Service (SaaS) business then one of those metrics should definitely be your annual recurring revenue, commonly referred to as ARR. Let's take a look at ARR, how to calculate it, and why it's such an important measure for your business.

What is ARR and How to Calculate it

ARR is the amount of money that comes in every year for the life of a subscription or contract. For example, if you sign a two-year contract with a customer for $20,000, then your ARR would be $10,000 each year. Simply put, ARR is your predictable revenue that can be counted on every year.

To calculate your ARR, start with your revenue and then subtract out ANY one time costs. This could include things like implementation fees, training and support, pilot fees, or non-recurring add-ons. All too often I see founders try to loop these one-time payments into their ARR and this practice is not correct. Trying to inflate your ARR is not a good long run strategy and any investor that knows what they are doing has seen this trick before. Stick to showing the repeatable revenue and highlight other metrics besides ARR if you don't have a lot of paying customers yet (more to come on those in future posts).

Why is ARR so Important?

Now that we understand what ARR is, let's look at why it's such an important metric. First and foremost, your ARR gives a clear picture of the overall health of your business. It shows each customer's willingness to pay for your product on an annual basis. ARR is also a signal of stability for investors. It shows them what revenue can predictably be repeated year over year and provides a baseline that you can attempt to grow off of. ARR is also a great benchmark that can be used to evaluate management decisions. Trying to sell to more mid-sized customers? Did ARR go up? If yes, then maybe that was a good call. If on the other hand you lost ARR because you neglected a smaller customer and they left, then that go-to-market strategy might need to be revisited. Your ARR provides insight into what is working with customers and what isn't.

Conclusion

When it comes to SaaS metrics, ARR is king. ARR is valuable benchmark that shows how your company is doing overall and can be used to track how you are doing against your competitors. Remember to only have revenue that is RECURRING in your ARR, take out all one-time payments. If ARR is something you aren't tracking, then you definitely need to start. If you need help calculating your ARR or advice on how to grow it, reach out to us at InfleXion Point. We are happy to help!