Annual Recurring Revenue
Definition
Annual Recurring Revenue
Annual recurring revenue is the annualised value of the subscriptions a business has active at a point in time. It is a run rate, not an accounting result, and treating it as revenue is the commonest error made with it.
The measure answers one question: if nothing changed, what would the next twelve months of recurring income be. That makes it a forward-looking indicator of the subscription base rather than a record of what has been earned.
Only recurring items belong in it. Professional services, one-off fees, hardware and usage above a committed level are conventionally excluded — because none of them will repeat automatically.
Definitions still differ enough to matter. Whether committed but unstarted contracts count, and whether contracts in notice periods are removed, can move a reported figure by several percentage points.
That is why investors ask for the definition before the number. A business that changes its treatment between periods can show growth that came entirely from the accounting of it — and the change is rarely highlighted.
Key takeaways
- The measure is a point-in-time run rate of active recurring subscriptions.
- Non-recurring items are excluded, which is what makes it comparable over time.
- It is not a reported accounting figure and follows no accounting standard.
- Movement is explained by new, expansion, contraction and churn together.
How it works
Take every active recurring subscription, normalise each to an annual value, and sum them. Monthly contracts are multiplied by twelve, multi-year contracts are taken at their annual rate, and non-recurring items are stripped out.
Movement analysis is where the measure becomes useful. Opening balance plus new plus expansion minus contraction minus churn gives the closing balance, and each component points at a different part of the business.
Subscription mechanics define what counts as active. Billing documentation describes how subscriptions move through a predictable set of states from creation to cancellation, which is the boundary the calculation depends on.
Accounting takes a different view. IFRS 15 has been effective for annual reporting periods beginning on or after 1 January 2018, and its five-step model governs reported revenue rather than any run rate.
| Component | Included | Reason |
|---|---|---|
| Monthly subscriptions | Yes, times twelve | Recurring by design |
| Multi-year contracts | Yes, at annual rate | Recurring commitment |
| Implementation fees | No | Does not repeat |
| Usage above commitment | No | Not contractually recurring |
| Contracts in notice | Treatment varies | Definition must be stated |
Examples
The measure behaves quite differently across business models, and its weaknesses show up fastest where income is not genuinely recurring. The four cases below show where those limits appear in practice.
A subscription software business reports the figure monthly with full movement analysis. Its board reads net revenue retention alongside it, because growth and churn offset each other.
An outsourcing provider on rolling contracts reports it cautiously. Contracts terminable on ninety days’ notice are recurring in form, and customer churn rate is the check on that assumption.
A usage-priced platform finds most income falls outside the measure. It reports a committed figure separately from consumption, and revenue per employee becomes the more useful operating measure.
A services firm with project work reports it for the subscription component only. Mixing project income into the figure would make the revenue share model look recurring when it is not.
Related terms
Several measures describe recurring income from different angles, and the entries below separate the stock from the flow and from the retention view. Each is read alongside the others rather than instead of them.
- Average lifetime value: the total a customer is expected to contribute over the relationship.
- Customer retention rate: the logo measure that sits behind churn in the movement analysis.
- Customer lifetime value: the projected value that recurring revenue assumptions feed into.
FAQ
How does this differ from annual contract value?
This is a run rate across all active customers at a point in time. Annual contract value is a per-contract figure derived from what was signed.
Is it an accounting measure?
No. It follows no accounting standard and appears in no audited statement. Reported revenue is governed by standards that treat timing quite differently.
Should usage revenue be included?
Only the committed floor, if anything. Consumption above commitment is real income but not contractually recurring, so including it overstates the base.
How should contracts in notice be treated?
Consistently, and the treatment should be disclosed. Removing them is more conservative; keeping them until expiry is more common and needs stating.
Why does movement analysis matter more than the total?
Because two businesses with identical totals can be growing and shrinking respectively. New, expansion, contraction and churn explain what the headline hides.
Does it work for non-subscription businesses?
Poorly. Where income depends on projects or consumption, the measure describes a small part of the business and invites false comparison with subscription peers.
Providers reporting recurring revenue can present capability through Outsource Accelerator hubs.
Independent
