Definition: Annual Recurring Revenue or ARR is a revenue model that can generate recurring cash flow regardless of the size of your customer base or the type of transaction. Instead of taxing each customer individually, ARR allows us to split the bill (fees included) among all customers who create product or service purchases within a set time frame.
Financial analysts and management use this metric to evaluate and measure the potential for future cash flows generated by a company. For example, it is instrumental in measuring recurring pre-paid revenue paid by customers rather than charged-off balances on existing accounts. In addition, it is typically used to measure the potential for a company to generate new cash flows in the future via new or revised product offerings or changes in customer behavior.
Annual recurring revenue (ARR) is similar to monthly recurring revenue (MRR) but measures the total amount of money generated by a company for all periods during the year. This includes both revenues generated from sales and revenue generated from licenses/subscriptions. The primary difference between ARR and MRR is that while the former primarily represents the current year’s revenue, the latter also reflects projected future periods (often referred to as five-year dividend yields or longer-term cash flows). Thus, in contrast to monthly recurring revenue metrics, which are usually defined in terms of revenues, annual recurring revenue metrics involve both the period during which a business operates and its potential for generating revenues in future periods.
Uses of Annual recurring revenue or ARR
- Annual recurring revenue is one of the common ways to measure business growth. An increasing number of organizations, including health, education, logistics, or retail organizations, track ARR because it provides reliable measurements of underlying growth or profitability and allows managers to make apportioned resources more effectively across the year without the hassle of constantly updating one’s revenue calculation.
- ARR allows companies to measure the impact of their product brand on ARR subscribers over time. It helps subscription services companies identify whether their model is succeeding or not by measuring average monthly revenue per user (MMSU) within a specified time frame. This allows subscription services companies to make informed decisions on whether to renew their contracts with their customers.
- With ARR, you can see how much revenue you will generate over a set period. This can help you determine whether your company is profitable and where the gaps are in your accounting systems. It can also be used to help decide whether you will need to raise additional capital. In essence, ARR is a system for tracking recurring revenue throughout your business.
ARR is a vital calculation to track if you’re running a profitable business. Unlike profits earned on sales, ARR can be earned on any source of revenue whether it’s a one-time event or a recurring source. As a result, you can think of ARR as your business’s operating budget. It represents the money your business will spend in the current period and is often used by financial analysts to help make investment decisions.