What Is ARR (Annual Recurring Revenue)?

ARR (annual recurring revenue) is the subscription revenue a business can expect to repeat over the next twelve months, counting only active recurring contracts. The formula is ARR = MRR × 12, or the sum of every active contract's annual value. One-off setup fees, professional services and usage overages stay out.

ARR is a snapshot, not a forecast. It tells you what your current contracts are worth over a year if nothing changes: no new customers, no cancellations, no upgrades. That is why investors ask for it first and why it is so easy to inflate.

The ARR formula, two ways

The quick method multiplies monthly recurring revenue by twelve. It works when most customers pay monthly and prices are stable, and it is the definition Stripe uses in its explanation of MRR and ARR.

The contract method adds up the annual value of each active recurring contract. A monthly plan counts at twelve times its price, an annual plan at its yearly price, and a multi-year contract at its total value divided by the number of years. This is the method to use once you sell annual or multi-year deals.

Public companies often go one step further and pro-rate by day. Commvault, for example, told the SEC in a 2025 response letter that it calculates ARR by dividing total contract value by the days in the contract term and multiplying by 365. Same idea, finer grain.

What counts in ARR and what does not

The exclusion list is where most definitions go vague, so here it is in one place. The test for every line is simple: will this money repeat next year without a new sale?

Usage-based pricing is the grey zone. If a customer commits to a minimum annual spend, that minimum is recurring and belongs in ARR; the overage above it does not. Teams that price on usage should decide the rule once and write it down, a point we cover in how to price an AI SaaS.

A worked example

Take a small software company with three kinds of customer at the end of the quarter. It also billed some one-off work that month, which we will deliberately leave out.

The ARR is $54,870. Divide by twelve and the matching MRR is $4,572.50. The company also billed $3,000 in setup fees, $5,000 of implementation work and $1,200 in usage overages that quarter, and none of it appears above.

Notice what the three-year deals do. Each contract is worth $36,000 in total, but only $12,000 of it counts toward ARR, because ARR measures one year. Putting the full $36,000 in would triple those customers' weight in the number.

ARR vs MRR vs revenue vs bookings

These four numbers describe the same contracts from different angles, and mixing them up is the most common way a pitch deck loses credibility. The table uses the three-year, $36,000 contract from the example, signed and billed annually in advance.

Revenue is the only one with an accounting standard behind it. Your books recognize subscription revenue as the service is delivered, which is why the $12,000 collected in advance sits as deferred revenue and moves onto the income statement one month at a time. If you are setting up books for the first time, our review of AI bookkeeping software for startups covers what handles this well.

Run rate is a cousin worth naming. Revenue run rate annualizes all revenue from a recent period, including services and one-off fees, so it will usually sit above ARR. Quote it if you like, but never under the ARR label.

Why investors ask for ARR

Subscription businesses are commonly valued as a multiple of ARR, because recurring contracts are the most predictable part of revenue. A dollar of ARR from a customer who renews for years is worth far more than a dollar of one-off project work, and the multiple reflects that.

ARR is also the shorthand founders use to describe stage. When someone says a company is "at a million in ARR", they are describing its contracted recurring base, not last year's income statement. If you are heading toward a raise, our comparison of startup accelerators shows how much programmes weigh traction like this.

The catch is that ARR is not defined by any accounting standard. Each company writes its own definition, which is why serious investors ask exactly how you calculate it before they apply any multiple.

Where founders get ARR wrong

Annualizing a good month. A month with a $1,200 usage spike, multiplied by twelve, adds $14,400 of ARR that nobody has contracted to pay. Use contracted recurring amounts, not last month's invoice total.

Annualizing short contracts. A three-month paid pilot for $6,000 annualizes to $24,000, four times what the customer actually signed. The SEC raised exactly this with Alteryx in a 2023 comment letter, and the company agreed to rename the metric "annualized recurring revenue" and disclose that short contracts inflate it.

Counting customers who have already left. A customer who has given notice, or whose card has failed for weeks with no response, is not recurring revenue. Remove them when you know, not when the contract technically ends.

Counting signed but unstarted deals. A contract that begins in three months is real, but it is not live. Track it as contracted ARR, a separate line, so the headline number only reflects customers you are serving today.

Blending services into the number. Implementation and consulting fees make ARR look bigger and make the business look less like software. Investors will strip them out, so do it first.

Does ARR apply if you sell products, not subscriptions?

Mostly no, and pretending otherwise misleads you. An online store selling one-off orders has no contracts that renew, so it has no ARR, however loyal its customers are. Annualizing last month's sales is a run rate, not recurring revenue.

The exception is the part of the business that genuinely subscribes: a replenishment plan, a subscription box or a paid membership. Those subscribers have ARR, and it is worth tracking separately from one-off sales, because it behaves differently. For everything else, the useful numbers are repeat purchase rate, average order value and contribution margin, which the ecommerce back office guide walks through.

If you want those numbers turned into a budget and a forecast, that is the finance work an AI co-founder can take on, alongside your bookkeeper rather than instead of one.

How to calculate your ARR this week

Export every active subscription with its price, billing interval and start and end dates. Convert each to an annual value, net of recurring discounts. Drop anything that is a one-off, a trial, a service or a customer who has given notice.

Add what is left and you have ARR. Then write a two-line definition of what you counted and keep it unchanged, so next quarter's number is comparable with this one. Founders running lean, as in our guide to the one-person company with AI, get the most from a definition that never moves.