ARR = Best Day x 365. This is NOT how you calculate your Annual Recurring Revenue. Let me show you how to do it like a professional…
What to Include
Pull all your customer contracts. We are calculating a live ARR number, so only include customers that you are actually billing now.
Let’s go through an example…
I’m running FrankSaaS. Here are all my contracts:
- Five customers on monthly contracts at $1,000 per month
- 3 customers on annual contracts at $10,000 per year.
Here’s how I calculate my ARR:
- Monthly contracts: 5 x $1,000 x 12 = $60,000
- Annual contracts: 3 x $10,000 = $30,000
My ARR is $90,000. That’s a solid start, probably enough for a pre-seed round of $750,000 to $2 million.
What Not to Include
Never include any revenue that isn’t recurring. If you have revenue from pilots, consulting work, or setup fees, do not include those in ARR.
Don’t include any revenue from customers that have churned. If they’ve canceled, they no longer count.
If you’re giving a discount, only include the discounted price in your ARR calculation. Never use the full list price if you’re not actually charging that. And if they’re on a free trial, the ARR from that customer is 0.
Never include any revenue you haven’t closed. ARR is not about projections or pipeline.
Never annualize a single good day, week, or even month. Stick to the calculation I showed you above to find the annual value of all your contracts.
A single good day does not an ARR number make.
Annual Recurring Revenue vs. Annual Run Rate
Some companies that don’t have recurring revenue still use the ARR metric. But confusingly, it stands for something different: Annual Run Rate.
I don’t like this practice. It’s way too confusing.
If you’re a company that doesn’t have recurring revenue, like a marketplace, I don’t recommend using the term ARR. Instead, just tell us your monthly revenue, like this: “We had $25,000 in revenue in October.”
This avoids any ambiguity. No investor will feel misled.
Don’t Mess With the Numbers
Sometimes, a founder gives me a big juicy, ARR number. But when I dig into that number a little, I find out it’s BS.
In today’s hot market, this is happening more and more. So I’m digging deeper into these numbers.
When I find out the numbers are bogus, the founder loses all credibility. I would have rather seen a smaller number that was actually real!
Never mislead investors. Never give into the temptation to juice those numbers.
The world of startups is a very small one. If you become known for peddling BS, the word will get around.
When a founder attempts to mislead investors, they also open themselves to liability. No one is trying to get you in legal trouble for an honest mistake, but actual intent to defraud is a very serious crime.
Wrap-Up
Keep your numbers clean.
Calculate your ARR the way I showed you. And when it comes time to raise money, work with a good accountant to make sure all the figures line up.
The tighter your books are, the easier it will be to pass a VC’s due diligence. That’s a critical step before the money hits your account.
Markets are hot, and there’s a lot of chicanery out there right now.
Ignore it. Be honest, forthright, and tell it like it is.
If you can do that, you just might find some people who believe in your vision just as much as you do.
There will be no blog tomorrow. I’ll see you again on Friday. Happy Thanksgiving! 🦃
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