How ARR Impacts Valuation: Understanding the Connection

This article explains the link between Annual Recurring Revenue and valuation and provides the latest ARR valuation multiples.

Share this article

Share this article:

Facebook
Twitter
LinkedIn
Reddit

Introduction

The purpose of this article is to explain the link between Annual Recurring Revenue, ARR, and valuation. It provides a quick overview of how to calculate ARR, explains the direct link to valuation and provides some practical tips to increase ARR.

What is ARR?

ARR stands for Annual Recurring Revenue. It is the amount of revenue that a SaaS (Software as a Service) company can expect to receive from its customers each year. ARR is calculated by multiplying the monthly recurring revenue (MRR) by 12 or by assessing the annual value of all recurring contracts.

ARR & MRR finance calculation formula

What is ARR Growth Rate?

ARR growth rate is the rate at which a SaaS company’s Annual Recurring Revenue is increasing year over year. It is calculated by assessing the change in revenue over a 12-month period. Here is the formula for calculating ARR growth rate below:

ARR Growth Rate Calulation Formula

How is ARR linked to valuation?

Historically, investors have considered ARR Growth Rate as the single most important metric for determining the value and growth potential of SaaS companies.  

Investors value SaaS companies based on their growth potential. Higher growth rates command higher valuations. Lower growth rates lead to lower valuations. This is because they can suggest that the company could be reaching a growth plateau.

How does the relationship between ARR and valuation change as SaaS companies grow?

As SaaS companies grow, the link between ARR and valuation can change. Early-stage companies may have high growth rates but lower ARR. Valuing such companies may depend on their potential for future growth. As companies mature and establish a more predictable revenue stream, ARR becomes a more important metric for valuation. It provides a clearer picture of the company’s stability and growth potential.

Benchmarking data provides the best view of the relationship between ARR and valuation. See our article on ARR Valuation Benchmarking here.  The best benchmarks to consider:

  • A company’s stage of growth, with specific metrics for smaller SaaS companies
  • Customer profile: ARR growth rates can vary by ideal customer profile
  • Public SaaS valuations

These factors are used to establish a multiple linking ARR and valuation. In Q4 2022, for example, publicly traded SaaS companies are trading around 5.6x ARR. This means that the company valuation is ARR multiplied by 5.6.

ARR Valuation Multiples

This graph shows the ARR multiples over the last three years. Current multiples are at the lowest level since the onslaught of COVID-19 in Q1 2020.

What practical steps can you take to increase ARR?

There are several practical steps that SaaS companies can take to increase their ARR. Some of these steps include:

  • Focusing on customer retention: Retaining existing customers is generally more cost-effective than acquiring new ones. Therefore, SaaS companies should focus on
  • improving customer retention rates to increase ARR: Offering value-added services or add-on products: Offering additional services or features can help to increase the value of a SaaS product. This can make it more attractive to customers, which can ultimately lead to higher ARR.
  • Increasing prices: If a SaaS company is providing value to its customers, it may be able to increase prices without losing customers, which can help to increase ARR.
  • Expanding into new markets: this can help increase the customer base and revenue streams, which can lead to a higher outcome.
  • Improving sales and marketing strategies: Improving sales and marketing strategies can help to attract new customers and increase revenue streams, which can lead to higher.

Ultimately, increasing ARR requires creating higher revenue through secure long term contracts.

Conclusion

ScaleXP is the leading SaaS finance tool, able to provide a full suite of SaaS metrics, automatically calculated each month. The system connects to and imports data from both your accounting (Xero or NetSuite) and CRM (HubSpot or Salesforce) systems. As data is imported, a series of smart algorithms prepare a revenue recognition schedules and a full ARR schedule, broken down by customer.

Click here to learn if we integrate with your systems. Or if you’re not ready to start yet but still want to learn more about ARR and tips on increasing your valuation, subscribe to our newsletter to stay up-to-date on the latest insights and trends.

Automate Customer Churn

Empower your business with real-time, automated SaaS metrics from MRR & ARR to acquisition costs.

Keep on the pulse

Sign-up for our newsletter to receive new benchmarks, metrics and reports for the modern day CFO.

  1. Monthly newsletters – just the right
    amount in our opinion.
  2. Curated with top-level CFO content
    you actually want to read.
  3. Your data is safe and will never be
    shared
     with any third party.

Join for helpful articles on benchmarks, financing and automation trends. Delivered straight to your mailbox once per month.

Global SaaS? Automate Your KPIs Quickly and Effectively with ScaleXP

ScaleXP: Your solution for global SaaS financial reporting and analysis Running a global SaaS business is thrilling, but financial management across borders can quickly turn

Read More »
Who at Your Business Can Benefit from Understanding Your ARR?

In the world of subscriptions, ARR (Annual Recurring Revenue) is way more than just a fancy accounting term. It’s a secret weapon for guiding strategies

Read More »
How ARR Valuation Helps CFOs Assess the Value of a SaaS Company

When it comes to Software as a Service (SaaS), Annual Recurring Revenue (ARR) stands out as a vital metric, guiding Chief Financial Officers (CFOs) and

Read More »