ARR definition
Annual Recurring Revenue (ARR) is the normalised, annualised value of all active subscription or recurring contracts at a point in time. If a customer is paying £2,000 per month on a rolling subscription, they contribute £24,000 to ARR. If they are on a £30,000 annual contract, they contribute £30,000 to ARR — regardless of how much has actually been billed or collected to date.
ARR is a stock measure, not a flow measure: it represents the recurring revenue run-rate at a snapshot in time, not the revenue earned over a period. This makes it fundamentally different from GAAP revenue, which is earned and recognised over time. A SaaS company can be growing ARR rapidly while GAAP revenue lags, because contracted revenue is recognised gradually over the subscription term.
ARR vs MRR
Monthly Recurring Revenue (MRR) is simply ARR divided by 12. The two metrics are conceptually identical — MRR is more common in businesses with monthly billing or high intra-year volatility, while ARR is the standard in enterprise SaaS with annual contracts. Most SaaS investors and analysts use ARR as the headline metric because it normalises for billing frequency.
When reading SaaS financial models, always check which metric is being quoted. A company reporting "$10m ARR" has the same recurring revenue base as one reporting "$833k MRR" — confusing the two is a common source of error in investor presentations and financial models.
The ARR waterfall
The ARR waterfall is the most important planning and reporting tool in SaaS FP&A. It explains how closing ARR is derived from opening ARR across four movements:
New ARR: ARR added from brand-new customers signing up in the period.
Expansion ARR: ARR added from existing customers upgrading, buying additional seats, or expanding their usage. This is the most capital-efficient form of growth — it carries no CAC.
Contraction ARR: ARR lost from existing customers downgrading or reducing their subscription. Contraction is a warning signal that often precedes full churn.
Churned ARR: ARR lost from customers cancelling entirely.
Net New ARR = New ARR + Expansion ARR − Contraction ARR − Churned ARR. A SaaS business with strong NRR will see Expansion ARR outweigh Contraction + Churn, meaning the existing base is self-growing even before any new customer acquisition.
ARR in financial planning and investor reporting
ARR is the foundational input to almost every other SaaS metric. CAC Payback Period is calculated per unit of ARR won. NRR is the ratio of retained-and-expanded ARR to opening ARR. The Rule of 40 uses ARR growth rate as its primary input. Valuation multiples in SaaS transactions are almost always quoted as a multiple of ARR (e.g. "we raised at 8x ARR").
For SaaS CFOs, the key planning question is: at what ARR growth rate, with what churn and expansion profile, do we reach profitability or a specific ARR milestone? This question is answered by a forward ARR waterfall model that stress-tests growth, retention, and burn across scenarios. Building and maintaining that model — with granular cohort assumptions — is core to SaaS FP&A.
