Annual Recurring Revenue: Is it a useful metric or lipstick on a pig?

Nick Sundich Nick Sundich, March 9, 2023

Annual Recurring Revenue (ARR), sometimes called Annualised Recurring Revenue, is a metric you’ll hear some ASX small caps use.

What does this term mean? Is it the same as actual revenue and is it a useful guide as to a business’ performance?

 

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Annual Recurring Revenue vs (ordinary) revenue

As you might except, there can be a time lag between a company signing a contract and revenues being received.

Sometimes there may be no revenues for several months or there may just be some of the money paid up front.

Revenue only recognises actual cash that has come in the door.

But Annual Recurring Revenue alludes to money a company it expects to receive from its customers who have made a subscription and consequently received goods or services.

The company in question may or may not have actually received that money. Although it will have a reasonable expectation of receiving it because it will typically have a signed contract with that customer.

It is important to note that Annual Recurring Revenue is not an accounting metric, so you won’t find it in a company’s financial statements.

 

What about ACV or TCV?

You might also hear Annual Contract Value (ACV) or Total Contract Value (TCV) used by companies. These are similar terms but slightly different in their calculation.

Annual Recurring Revenue takes into account how much recurring revenue you can expect based on yearly subscriptions.

But ACV is the value of subscription revenue from each contracted customer, normalised across a year.

Nevertheless, they serve similar purposes for companies that use them, illustrating to investors what statutory revenue cannot (right away).

 

So is Annual Recurring Revenue a useful metric?

Simply put, Annual Recurring Revenue is useful but it shouldn’t be used in isolation.

Investors need to consider Annual Recurring Revenue in conjunction with statutory revenue and cash flows.

For some companies there may be little to no difference – Infomedia (ASX:IFM) is one such example.

For other companies, however, there may be a significant difference. Vection (ASX:VR1) is one example, with a TCV of $24m despite only generating ~$4.5m in cash from operating activities reach quarter.

 

What if Annual Recurring Revenue is different to statutory revenue?

In cases such as the latter, investors need to check carefully for two things.

First, check if company isn’t trying to inflate itself by using a non-accounting metric.

And second, if there are special reasons why the company is not converting Annual Recurring Revenue, TCV or ACV to statutory revenue.

Perhaps there might be debt collection issues with the company. Alternatively, a company may have signed a deal significantly back-ended (which is to say having revenues flowing towards the latter half of the contract’s duration).

When receipt of Annual Recurring Revenue is delayed from one financial year to another, this can be a problem.

Even if it is only because it is delayed from 4Q of one year to 1Q if the next, this can have an impact on results due to revenues being lower than they otherwise would be.

 

Investors should know about Annual Recurring Revenue

Once again we note that, Annual Recurring Revenue is useful but it shouldn’t be used in isolation.

The same principle goes for any other metric. Any investment decision needs to be based on a multitude of factors that overall weigh favourably to the company.

 

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