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by K street capital /

January 25, 2022


5 Things SaaS Companies Need to Know About Calculating ARR

ARR is the single MOST important metric that you’ll track—even more than your revenue itself, namely because it’s the most important number to buyers and investors, who want to see clear indications of predictable future revenue. Unfortunately, it’s also an intricate measurement to calculate properly.

Regular financial tracking is a must for any company, but SaaS companies have a unique set of metrics they should keep up to date—particularly if considering an exit strategy.

And while all metrics are important, ARR (Annual Recurring Revenue) takes the cake.

Why is ARR so important for SaaS companies?

ARR is the single MOST important metric that you’ll track—even more than your revenue itself, namely because it’s the most important number to buyers and investors, who want to see clear indications of predictable future revenue. Unfortunately, it’s also an intricate measurement to calculate properly.

We’ve seen many companies struggle with ARR over the years. Some struggle with the initial calculation, while others find out the hard way that, while it’s never really too late, not properly maintaining ARR comes with unpleasant consequences.

For example, one company came to us knowing it wanted to start fundraising in the next year. After reviewing their information, we recommended they take a step back and clean up their records and ARR schedules since they’d need accurate numbers to actually close a deal. They chose to forge forward, and sure enough, in the middle of the raise, they needed an accurate ARR number to get through diligence. By delaying, they created additional work to rectify their calculation—so much so that they nearly ran out of cash while trying to close the deal.

Thankfully, we were able help in time, but it wasn’t without an experienced team and many, many overnight hours for the company’s employees. And while we’re happy it ended well, the struggle, anxiety, and additional expense could have been easily avoided by simply doing the legwork upfront to have an accurate ARR at their fingertips when they needed it.

This is surprisingly not uncommon. Your ARR matters—there’s no avoiding it if at any point you might pursue investors or an exit. But what exactly goes into calculating ARR?

Example of an ARR Calculation

Here are the top five fundamental things you need to know to calculate your ARR

1. ARR is a point-in-time number

This may seem obvious but, your ARR isn’t a sum of multiple past points in time: It’s an indicator of your future numbers, based on the present.

Shockingly often, we see people try to calculate ARR by adding months or points in time. However, by doing this, they’re accidentally inflating a number that isn’t a true representation since ARR is already annualized.

2. One-time fees and implementation costs don’t count.

ARR indicates future revenue, so it only considers recurring fees. For example, if your company secured a new $50K annual contract with a one-time $3K set-up fee, the number that counts for that specific contract is not $53K; it’s $50K.

However, if there’s a yearly maintenance fee on top of the recurring subscription cost, that annual fee would count since it recurs in the future. In short, one-time fees don’t factor into ARR; anything that will register regularly for the duration of the contract does.

3. Free trials don’t count toward ARR.

To properly maintain your ARR, you should track it regularly; once a month is fairly standard. Many SaaS companies offer a free trial before starting official service, and while the lengths of those trials may vary, if you’re regularly tracking your number, it’s safe to say you’ll have customers in trials when you pull it. You cannot include trial customers in your ARR calculations. You can only include them once the customer has a signed contract that is active within its paid duration.

One thing worth noting here is that, while you should have your true “trial-free” ARR number available to investors, that doesn’t mean you can’t also share with them your projected ARR (should all those trials happily turn into paid contracts). Don’t sell yourself short.

4. You must accurately represent discounts.

Since ARR shows a revenue projection, your calculation should reflect the actual contracted price—not “retail.” For example, if your standard annual price is $20K but a customer signed up under a promo and only pays $18K, you only count $18K toward the ARR. However, if you have a multi-year contract and the discount applies only to part of the term, you should average out the price over the contract’s total number of months to reflect the discount and regular price as they’ll apply.

It's also worth sharing that discounts are a hotly contested topic that often gets shoved under the rug. While the above method is most standard, some companies report contracted ARR as if the discount never existed (which is a bit of an over estimation). Instead, they report “billable ARR” in addition to contracted ARR. Billable ARR deducts discounts, backlogged orders, and delayed billing terms in their final number.

5. Regular maintenance is the key to ARR success.

If you think you might ever exit or do a raise, you’ll need your ARR. This number is complex and requires accurate records at all times. If you aren’t confident in your number or that you have the data or experience to accurately calculate it, let us know —we’re experts here and can help. If you’re thinking about taking it on yourself, this part may be the most important of all: You need to maintain your records across systems and time.

When contracts renew or move into their next year of a multi-year contract, many customers will upgrade or downgrade. These contract changes will affect your ARR.

The system you use to track and pull ARR needs to track:

  • Contract start and end dates,
  • Currency,
  • Total contract value, and
  • The annual recurring portion (vs one-time fees)

These numbers should come directly from the contract: Don’t make assumptions—manually read contracts and input data accordingly. Only the numbers in the contract matter—so if you do have changes, make sure you have a signed contract to match.

If you use a CRM like Salesforce or Hubspot, you must train sales staff or whoever will input these numbers about what ARR is, its importance, and how to accurately enter the data.

Even with trained staff, the best practice is to do a reconciliation to ensure accuracy. Each month your finance team should crosscheck any new, churned, changed, or renewed contracts to ensure your CRM or contract system reflects the correct numbers.

The earlier you start tracking your ARR and maintaining the records necessary to calculate it, the better off you’ll be. If you’re already behind, it’s never too late to start, even if you need to hire an experienced SaaS FP&A consultant to help you get on track. Believe me, there’s no way to avoid ARR.

Need more help knowing understanding how to prepare for your next steps? Check out our related post on prepping or contact us with questions.

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