What is annual recurring revenue (ARR) and how to calculate it

Annual recurring revenue (ARR) is a critical metric for evaluating the financial health and growth trajectory of subscription-based businesses. Whether you're a SaaS startup or a small business with recurring contracts, ARR offers a reliable way to measure predictable income year over year.

Take Ramp, for example: We've more than doubled our annualized revenue to $700 million as of January 2025—an impressive benchmark that underscores just how powerful recurring revenue can be when paired with scale, efficiency, and strong product-market fit.

We’ll explain the meaning of annual recurring revenue, how it can be calculated, and why it’s a handy metric for startups and small businesses. Additionally, we'll look at some common mistakes companies make when interpreting the results of an ARR calculation and share some tips for growing recurring revenue into the future.

What is ARR?

ARR is the revenue a company generates yearly based on predictable, recurring charges to its customer base. Most commonly, ARR is used by businesses utilizing a subscription model, such as B2C streaming services like Netflix or Hulu, or contract-based B2B service providers such as software-as-a-service (SaaS) companies.

ARR is calculated by adding the total recurring revenue generated from customers annually, including through product upgrades and add-ons, and subtracting losses incurred through downgrades and cancellations or churn.

Why is ARR important for small businesses and startups?

As a new or relatively small organization, ARR will be one of several reliable indicators of the overall health of your business. Here are just a few specific benefits to consider:

• Forecasting revenue: ARR helps companies with financial forecasting or accurately predicting future revenue. Knowing what to expect in advance can dramatically improve financing planning and analysis initiatives. You'll also better understand how to manage cash flows and allocate resources throughout the company more effectively.
• Attracting investors: ‍Attracting investors during your company’s early stages ensures continued growth. Interested parties will need a reliable way to assess your business’s performance and to determine if they can expect the business model to remain successful in the long term.
• Evaluating the success of your business model: ‍Launching a successful subscription business or SaaS company requires a fair amount of trial and error. There will likely be room to improve your business model in the early stages, and calculating ARR will help reveal your strengths and pain points and ultimately identify where adjustments should be made.

ARR formula

How do you calculate annualized recurring revenue? While the specific process will vary significantly depending on the complexity of the business model in question, a generalized annual recurring revenue formula is as follows:

To provide a better idea of the ARR formula should be implemented in relation to your specific business model, here is a more in-depth explanation of how to calculate ARR and the financial information that may be required:

How to calculate ARR

First, determine the total value of annual revenue earned from recurring subscriptions or contracts before any upgrades or cancellations are factored in. This figure will be the base from which to make your final calculation and should be the easiest to derive from your company’s overall balance sheet.

Next, you will add all relevant expansion revenue and subtract losses from downgrades or cancellations. Here are some extra considerations to make when utilizing these figures to calculate ARR:

Adding expansion revenue

‍Expansion revenue is any additional revenue from a customer’s initial subscription or contract. Expansion revenue is created by upsell mechanisms built into your subscription model, giving your customers the option to pay a higher annual rate to gain access to upgraded features or benefits.

If your business model also includes separate add-on features that generate a recurring charge, the revenue created by these features must also be added to your base figure. Importantly, you must be careful to exclude items like non-recurring add-ons or features offered to customers for a one-time fee.

Subtracting lost revenue

‍To accurately calculate AR, it’s critical to subtract all revenue lost from product downgrades or cancellations. A downgrade will be any instance in which a customer adjusts their service plan, resulting in a lower annual fee. For example, a streaming service customer paying for ad-free access to TV shows may decide to downgrade to a cheaper plan that includes advertisements.

A cancellation will occur when a customer cancels their service and does not renew before the subscription expires. Cancellations factored into an ARR calculation will almost always contribute to your overall churn rate or the rate at which your customers cancel their subscriptions without returning. Churn may be calculated differently when addressing monthly recurring revenue (MRR).

When you get an accurate read of the above figures, they can be fed into the above formula to give you the final ARR.

Common mistakes made when interpreting ARR

While the formula for calculating ARR might seem straightforward, mistakes happen frequently and often lead to false or misleading interpretations. Here are a few of the most common mistakes and some brief tips on how to avoid them.

Mistaking ARR for cash flow

‍Maintaining accurate and up-to-date financial statements is critical for a growing business, and it’s not uncommon for ARR calculations to be factored into the wrong statement, resulting in a misleading picture of how funds are managed within your organization. Because recurring revenue is considered income, it should only be reflected in your income or P&L statement.

Failing to subtract discounts

‍Many businesses take too broad a view of recurring subscriptions and calculate the value of all active users based on the normal, non-discounted annual rate (e.g. $100/year). However, suppose you have recently offered your customers a discounted rate or a promotion (e.g. 25% off the normal rate). In that case, these customers will need to be accounted for and you will need to adjust your ARR to reflect the total value of all subscriptions.

Not accounting for late payments

‍Your customers won’t always pay on time, and ARR is meant to account only for reliable recurring revenue streams. Therefore, customers who are currently late on their annual payments should be placed in the category of lost revenue, and the corresponding value should be deducted accordingly.

What is an example of ARR?

Here’s a simple example of Annual Recurring Revenue (ARR):

Let’s say you run a SaaS company that charges $1,000 per year for access to your platform. You currently have 100 active customers on annual contracts.

• ARR = $1,000 × 100 = $100,000

If 10 customers upgrade to a premium plan that costs an extra $500/year, and 5 customers cancel:

• Expansion Revenue = $500 × 10 = $5,000
• Churn = $1,000 × 5 = $5,000
• Final ARR = $100,000 + $5,000 (upgrades) - $5,000 (churn) = $100,000

How to increase annual recurring revenue

A positive ARR positioned for continued growth can be an attractive selling point to potential investors. Here are a few areas to focus on when attempting to boost your annual recurring revenue.

Reduce customer acquisition cost (CAC): The costs associated with generating new customers can add up quickly, and the more you spend to bring customers in, the less return you’ll ultimately realize on contracts and subscriptions. When you’re evaluating and interpreting ARR, you’ll want to compare recurring revenue with CAC and determine where factors like marketing spend can be reduced or more effectively leveraged to increase your ARR.

Increase retention/lifetime value of your customer base (LTV): As the total value that customers provide to your business, increasing your customer base's lifetime value (LTV) is critical to boosting ARR. The most reliable way to grow your LTV is to focus on improving initiatives surrounding customer retention. This might mean optimizing user experience at the application level or offering a more personalized customer service experience.

Consider new upgrades to incentivize engagement: Upgrades can go a long way toward increasing your overall ARR. After evaluating your business's current upgrades and add-ons, identify where new features might be added and integrated as part of a new subscription tier. Alternatively, depending on how active your customer base is, you may want to rethink your pricing strategy and adjust the price of certain services to reflect demand.

Take control of your finances with Ramp

Ramp helps startups and small businesses simplify expense management and improve profitability with a platform built for automation and control. In a complex financial environment, Ramp makes it easy to manage spending, streamline accounting, and track recurring revenue.

Key features include:

• Automated invoice reconciliation to reduce errors and save time
• Automatic categorization of transactions for easier ARR tracking
• Customizable spend controls to prevent overspending and enforce policies

Discover how Ramp’s small business card can help you grow ARR and take control of your finances.