How to Calculate Annual Recurring Revenue (For SaaS Companies)

Annual recurring revenue (ARR) is a critical metric for software as a service (SaaS) and other subscription-based businesses. It refers to the revenue a business can expect to receive in a year from recurring sources, as opposed to one-off payments.

Let’s explore how to calculate ARR, why it’s so useful for financial planning, and some strategies you can use to increase the metric.

The Annual Recurring Revenue Formula

There are many different formulas for ARR, but one of the most popular and practical ways to calculate it involves breaking down the SaaS metric into five different types of ARR. It looks like the following:

Total ARR = Existing ARR + New ARR + Upgrade ARR - Downgrade ARR - Churn ARR

Here’s what each of the variables in that ARR formula mean:

• Existing ARR: Also known as renewal ARR, this refers to the recurring revenue you expect to receive from existing customers you’ve already secured by the beginning of the year.
• New ARR: This refers to the recurring revenue from new subscribing customers you acquire during the year.
• Upgrade ARR: Also known as expansion revenue, this refers to the additional ongoing revenue from customers upgrading their subscriptions and increasing their payment amounts.
• Downgrade ARR: This refers to the recurring revenue lost due to customers downgrading their subscriptions and decreasing their payment amounts.
• Churn ARR: This refers to the recurring revenue lost due to existing customers canceling their subscriptions and ceasing their payments altogether.

Startups don’t always have a year’s worth of data for each of these variables, so they may tally them up on a monthly basis to find their monthly recurring revenue (MRR) and annualize the amount to calculate ARR.

What Is Annual Recurring Revenue? (And What Isn’t)

Annual recurring revenue only includes revenue from recurring sources. In this case, that refers to payments you can expect to continue receiving repeatedly, with monthly, quarterly, and annual subscription revenue being the primary examples.

ARR specifically excludes non-recurring sources of revenue, such as:

• Initial setup or admin fees for newly subscribed customers
• Sales of perpetual software licenses that don’t require renewal
• One-off sales of hardware that complements your SaaS solution 

For example, say Startup A gains a new customer who signs up for a $40 monthly recurring subscription with a $10 sign-up fee. They also purchase a $500 training session with one of Startup A’s live instructors to learn how to use the new software.

Startup A would only include the $40 monthly subscription in its ARR calculations. The $10 sign-up fee and $500 training session payment are both one-off aspects of customer lifetime value that it can’t count on receiving again. 

It’s possible the customer will buy more training, but there’s no guarantee of a continual revenue stream.

ARR is a metric designed to provide an estimate of the future revenue your business can count on receiving. That’s why it’s often so integral to financial forecasting and growth planning. 

Removing one-time payments from your ARR calculations will provide highly useful information, though it's not in accordance with GAAP revenue recognition standards.

Figures To Include in Your Calculations

As mentioned above, one of the most practical ways to calculate your total ARR is to net your existing ARR, new ARR, upgrade ARR, downgrade ARR, and churn ARR.

However, it often helps put things in perspective to look at these variables as components of two fundamental figures:

• The total number of customers you have
• The recurring revenue each customer generates

Your existing ARR, new ARR, and churn ARR effectively capture the number of customers you have during the year, adjusting the initial amount up or down to account for customers who sign up or cancel.

Meanwhile, upgrade ARR and downgrade ARR account for the increases and decreases in a customer’s recurring annual revenue value due to them switching to a more or less expensive subscription plan.

Another way to conceive of and calculate ARR is to multiply those two amounts, using the following formula:

ARR = (Number of customers) x (Average annual recurring revenue per customer)

Breaking ARR into the five components discussed previously is often more practical, but this formula is helpful for understanding what you're trying to capture with the metric.

ARR Calculation Example

Startup B is a B2C SaaS company that generates its monthly revenue by selling subscriptions to its proprietary software. It currently offers the following subscription tiers:

• Silver: $100 per month 
• Gold: $250 per month
• Platinum: $400 per month

Each subscription comes with a one-time $25 sign-up fee, but Startup B provides a 20% discount to new users for their first year.

At the beginning of 2025, Startup B has 400 existing customer subscriptions, with 200 at the Silver tier, 150 at the Gold tier, and 50 at the Platinum tier.

In January 2025, Startup B secures 5 Silver subscribers, 10 Gold subscribers, and 5 Platinum subscribers. It also loses 6 customers in line with its churn rate, with half at the Gold tier and half at the Platinum tier. 

Finally, 5 subscribers upgraded their subscriptions from Silver to Gold, and 10 downgraded from Platinum to Gold.

Here’s how you might calculate ARR for 2025 in this scenario, first by calculating MRR for January, then annualizing the amount:

Existing MRR = 200 Silver customers x $100 + 150 Gold customers x $250 + 50 Platinum customers x $400 = $77,500

New MRR = (5 Silver customers x $100 + 10 Gold customers x $250 + 5 Platinum customers x $400) x 80% = $5,000

Upgrade MRR = 5 customers x ($250 Gold rate – $100 Silver rate) = $750

Downgrade MRR = 10 customers x ($400 Platinum rate – $250 Gold rate) = $1,500

Churn MRR = 3 Gold customers x $250 + 3 Platinum customers x $400 = $1,950

ARR = ($77,500 existing MRR + $5,000 new MRR + $750 upgrade MRR – $1,500 downgrade MRR – $1,950 churn MRR) x 12 months = $957,600

Notice that the one-time $25 fee that Startup B charges new customers did not factor into these calculations because it’s not a source of recurring revenue.

ARR vs MRR

ARR and MRR are essentially the same metric, with the only difference being the period of time they deal with. ARR captures your recurring revenue on an annual basis, while MRR measures your recurring revenue in a single month.

The two metrics often go hand in hand, as they serve similar functions in financial planning. However, businesses may prefer to use one over the other if it better matches their subscription model.

For example, startups that only offer monthly subscriptions may prefer to use an MRR calculation, while those that primarily sell yearly subscription packages might prefer to work with ARR benchmarks.

MRR also tends to be a better reference point when analyzing short-term business decisions, while ARR may be a better measure of your startup’s long-term growth.

What Your ARR Tells You

Because ARR only includes your company’s recurring revenue, it’s a more accurate predictor of the gross receipts you can expect to receive going forward than total revenue. 

It eliminates one-off payments that might create fluctuations in your metrics and cloud your business’s actual growth rate.

As a result, ARR is a particularly useful tool for financial planning and analysis. Calculating a business decision’s potential impact on your ARR is an excellent way to gauge whether it’s beneficial to your company in the long term.

For example, you might analyze the effect of the following on your ARR before committing to them:

• Lead generation campaigns
• Customer retention strategies
• Subscription pricing adjustments

For SaaS companies and other businesses that use subscription-based pricing, your ARR growth rate arguably tells you more about your company’s predictable revenue growth than any other metric.

How To Increase ARR

Continually increasing your ARR is an effective strategy for creating sustainable future growth, and there are countless ways to do it. 

However, they all revolve around the two fundamental levers we discussed above: the number of customers you have and the recurring value each one generates.

Here are some basic strategies for improving these numbers and increasing your ARR metric:

• Acquire more customers: Expand your customer base with targeted marketing campaigns. Consider investing in social media and search engine optimization to attract new users organically, which may help lower your customer acquisition cost.
• Reduce customer churn: Find ways to keep your existing customers engaged and satisfied. For example, you could invest in your customer success and support team or upgrade your product based on the feedback from your users.
• Increase subscription prices: Review your prices regularly and consider increasing them over time to reflect the additional value you provide as your product improves. Just be careful not to raise them so much that you cause a net decrease in your ARR or cash flow due to downgrades and SaaS churn.
• Encourage subscription upgrades: Look for ways to upsell customers on higher membership tiers. If you can convince them to pay more for the additional features those tiers provide, you can extract more annual recurring revenue from each customer.

To calculate ARR and other valuable SaaS KPIs like SaaS deferred revenue, your business needs an effective bookkeeping system. An accurate record of your company’s activities is an essential foundation for financial analysis.

Zeni’s bookkeeping software is an excellent solution for businesses that use the recurring revenue model. 

Designed with SaaS financial modeling and planning in mind, it uses AI and machine learning to automatically categorize transactions and provide valuable insights into financial trends, including metrics like ARR.

In addition, Zeni’s bookkeeping comes with free bill pay and employee reimbursement services, plus a free business checking account that offers $3 million in FDIC insurance and earns up to 4.05% APY.

Schedule a demo today to see how Zeni can help streamline your finances.