# How to calculate ARR?

The ARR formula is simple and will show you how to calculate your ARR: ARR = (Overall Subscription Cost Per Year + Recurring Revenue From Add-ons or Upgrades) – Revenue Lost from Cancellations.

• Step one: Calculate total \$ amount of yearly subscription.
• Step two: Calculate total \$ amount gained by expantion revenue.
• Step three: Subtract total \$ amount lost due to cancelations (churn).
• Step four: Equals your ARR (Annual recurring revenue).

ARR is an acronym for Annual Recurring Revenue, and it’s also a metric for subscriptions companies (SaaS). We’ve discussed ARR elsewhere, but suffice it to say that Annual Recurring Revenue calculations are important to your subscriptions business. It allows you to determine how well your company is doing, because it lets you see the value of your recurring revenue normalized over a year.

### How to Calculate ARR? What is Included in ARR Calculations?

Typically, you only include fixed subscription fees in your calculations for your Annual Recurring Revenue (ARR). You’re determining those committed costs that are recurring. So, if your customer pays one-time fees for training or other service, you exclude those costs from your ARR. You also exclude any costs that fall outside that 12-month period, and you don’t count the fees that are not contractually guaranteed for the 12-month period of time.

For example, if the 3-year contract includes \$56,000, but \$20,000 of that cost is for other services and fees related to the subscription service, you only count the \$36,000 when you look at the ARR. So, you are looking at \$36,000 divided by 3 years, which you calculate at \$12,000 for your ARR.

#### Monthly Subscriptions

If your customer is contracted to pay \$200 every month for 12 months, your ARR would be \$24,000, excluding any one-time sign-up fees, or other professional service fees. The ARR is a way of measuring the revenue that you can reasonably expect to earn on an annual basis, based on the agreements that you’ve put into place with your customers. So, if your subscription service renews every month, you can only include the value for a subscription that is contractually obligated over the 12-month period. (That means, you just would not count that month-by-month subscription in your ARR.)

It can be a little confusing when you calculate your ARR, since you also may have upgrades or add-ons that you offer to your customers. For example, a customer started out with a single-user account, but then switched to a multi-user account, so the ARR does take into consideration that higher subscription rate for the annual calculation. Again, though, that value is taken into consideration when it is raked up on an annual basis. It must affect the annual subscription price your customer contractually agrees to pay.

It would be awesome if you never experienced any downgrades for your subscription service. That means a loss of revenue, but downgrades do happen, and you need to factor them into your ARR, when the downgrade is a change to the annual contract. Similarly, some customers may cancel their contract for whatever reason, and you also must take those cancellation numbers into consideration when you determine your ARR.

### Why is Correct ARR Calculation Important?

If it’s just one person looking at revenue and long-term projections, you can wrangle the numbers any way you want. When you start calculating the ARR and sharing those numbers with your partners, investors, and other key financial considerations in your company, you must make sure that you’re including the correct set of numbers in your calculations. If you’re including professional fees, training, or other monthly surcharges in your calculation, you’re contributing to a confusing and overzealous outlook on your company. It might look like your ARR is substantially higher than it really is. A false sense of the health of your SaaS company can lead you and your partners, investors, or other key personnel to make decisions and investments based on perceptions of positive growth projections.

Your accurate calculation of the ARR can also, conversely, tell you important details, even if your calculation is not as positive as you’d like to see. If your ARR is atrocious, at least you know that. By accurately calculating your ARR based on your current contractual subscriptions, you can take the next step to determine what you need to do to grow your business. If you determine that you need to double your subscription accounts that are under contract, for example, what steps do you need to take to make that happen?