In the business glossary, the annual run rate, short for ARR, is the annual version or monthly recurring revenue, i.e. MRR. Calculating the annual run rate and keeping a tab on it helps companies in projecting future revenue based on the data they have pertaining to the current revenue. Having said that, it is based on the assumption that nothing changes, i.e. there’s no expansion, no lost customers, and no new customers.
The assumption may make ARR seem unrealistic in the practical world. But, it has proven to be significant in predicting the long-term growth of the business. Besides that, it also helps stakeholders visualize the size of their business.
For instance, a $1 million business means a business with $1 ARR. In simple words, it the company is expected to produce $1 million in recurring revenue in the ongoing year.
How to Calculate ARR?
The process to calculate is easy. All you have to do is to annualize your MRR, i.e. multiply the figure by 12. To further simplify the process, install Baremetrics and see real-time ARR statistics in your personalized dashboard.
Is ARR Reliable?
As stated above, ARR has proven to be beneficial for businesses. However, it poses some problems as well. Firstly, it doesn’t take into account month-to-month sales. For instance, if you operate a seasonal business, you can’t calculate ARR on any month’s MRR. You have to factor in a month that has proven to be a lot beneficial for your business.
A way to resolve this issue is to calculate ARR on the basis of your quarterly MRR. This will prove you with a clear picture of your business’s growth over the passage of time.
More About ARR
Before shedding light on ARR, let’s first talk about accrual accounting. It is a type of accounting method that takes into account accounting events separately from when the business collects cash. In simple words, it applies the technique of matching revenues and expenses in the month (when these events occur).
For example, when you sign an annual subscription, 1/12th of the agreement value is reflected in each month. In terms of accrual accounting, the revenue isn’t accounted for until the service is received. This way, businesses get a clear picture of revenues and sales on a monthly basis.
Annual run rate, similar to MRR< is calculated by taking into account earned revenue only. Taking the above example into consideration, it doesn’t include the full amount in the month the subscription contract was told.
Simply put, the annual run rate is just monthly recurring revenue multiplied by 12. But, it’s calculation provides abundant benefits for businesses. These include:
Revenue Projection
ARR provides a reliable estimate of a company’s future revenue based on its current performance. It helps stakeholders gauge the company’s growth potential and make informed decisions about resource allocation and strategic planning.
Growth Monitoring
ARR enables businesses to track their growth trajectory over time. By comparing ARR figures across different periods, companies can assess the effectiveness of their sales and marketing strategies, identify trends, and measure the impact of new product launches or expansions.
Investor Confidence
ARR is a widely accepted metric in the SaaS industry. Investors often use ARR to evaluate the financial health and growth potential of SaaS companies, as it provides a clearer picture of recurring revenue and the company’s ability to generate predictable cash flow. Higher ARR figures can increase investor confidence and attract additional funding or investment opportunities.
Revenue Visibility
ARR offers better revenue visibility compared to other metrics, such as Monthly Recurring Revenue (MRR) or Quarterly Recurring Revenue (QRR). Since ARR projects annual revenue, it provides a longer-term perspective, allowing companies to make strategic decisions, allocate resources, and plan for future growth more effectively.
Valuation
ARR plays a crucial role in valuing SaaS companies. Many investors and potential acquirers use ARR as a key valuation metric to determine the worth of a company. Higher ARR figures often lead to more favorable valuations and can result in higher acquisition or investment offers.
Performance Benchmarking
ARR allows businesses to compare their performance with industry peers. By analyzing ARR data of competitors and similar companies, organizations can identify areas for improvement, set benchmarks, and track their progress against industry standards.
Revenue Forecasting
Based on historical ARR data, businesses can develop revenue forecasts and make data-driven predictions about their future financial performance. This enables better budgeting, resource allocation, and financial planning, helping companies align their growth strategies with revenue targets.
It’s worth noting that while ARR offers valuable insights and benefits, it should be used in conjunction with other financial and operational metrics to get a comprehensive understanding of a company’s performance and potential.
