Revenue is an excellent measure of growth and performance. The problem? Revenue means different things in different contexts.
- When an investor asks you about your revenue, you tell them your ARR (annual recurring revenue).
- When the SEC or IRS asks you about your revenue, you tell them the revenue amount calculated according to ASC 606 and Generally Accepted Accounting Principles (GAAP).
Understanding the distinction between GAAP revenue versus ARR is essential for financial reporting, valuation, and strategic decision-making.
What is GAAP Revenue
GAAP (Generally Accepted Accounting Principles) revenue refers to the revenue a company reports in its financial statements based on standardized accounting rules. GAAP ensures that companies record revenue when it is actually earned—not just when cash is received. This is the concept around revenue recognition.
For example:
- If a company sells a subscription service, GAAP revenue rules (like ASC 606) require it to recognize revenue over time as the service is delivered, rather than all at once when the payment is received.
In simple terms, GAAP revenue is the “official” revenue number a company reports, following strict accounting rules to ensure accuracy and consistency.
Revenue recognition is defined under ASC 606, which lays out a five-step process to ensure companies report revenue accurately. The five steps of ASC 606 are:
- Identify the contract with a customer.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to performance obligations.
- Recognize revenue when (or as) performance obligations are satisfied.
According to ASC 606, you don’t necessarily book revenue when you receive cash. Instead, you recognize revenue when the service is rendered or the product is sold, whether that happens all at once (like in retail) or gradually over time (like in SaaS).
Suppose a customer signs a 12-month deal worth $120,000 to use your SaaS product in January. Using GAAP principles, the company would recognize roughly $10,000 a month. By the end of the contract, the full $120,000 will have been recorded as revenue.
| Jan | Feb | Mar | Apr | May | Jun | Jul | Aug | Sept | Oct | Nov | Dec |
| 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 |
This is how the regulators like the SEC, want public businesses to report revenue. If you don’t follow GAAP guidelines, you could risk stakeholder trust, undergo intense audits, or misstate revenue on financial reports.
What is ARR
ARR is a forward-looking metric that represents the total expected recurring revenue over the next 12 months from subscription-based contracts. It is a key metric for SaaS companies and investors because it reflects revenue predictability and growth.
How is ARR Calculated?
ARR=Total Monthly Recurring Revenue x 12
Example:
- A customer signs a 12-month contract at $1,000/month.
- ARR = $1,000 x 12 = $12,000.
Why ARR Matters
- Investors prioritize ARR to assess revenue momentum and growth potential.
- Companies use ARR as a key metric to track business scalability.
- ARR is not regulated, meaning companies may define it differently.
SaaS companies tweak the ARR calculation slightly based on their circumstances. That’s okay because ARR is not required to be reported on any financial statements.
The problem? ARR drives cash flow and, by the same token, your business’s valuation. That’s why investors like to look at ARR and typically pay attention to what went into the calculation.
GAAP Revenue Vs. ARR
The SEC requires public companies to report GAAP revenue. Private companies need to comply with ASC 606 if they follow U.S. GAAP for financial reporting. However, private companies that do not follow GAAP (e.g., small businesses using cash accounting) may not be required to adhere to ASC 606.
On the other hand, ARR is an operating metric. It’s not mandatory to report on any financial statements. But if you’re backed by a venture capital or private equity firm or plan to raise funds from them, tracking and reporting ARR is critical.
As companies grow, they gradually transition from using ARR as their “North Star” metric to using GAAP revenue because ARRs can paint a skewed picture.
GAAP Revenue vs. ARR: Key Differences
| Factor | GAAP Revenue | ARR |
| Definition | Revenue recognized per ASC 606 | Forward-looking metric based on contracts |
| Regulatory Requirement | Mandatory for financial reporting | Not required for financial statements |
| Timing | Recognized when service is delivered | Includes all signed recurring revenue |
| Predictability | Historical and actual revenue | Forward-looking and estimated |
For example, let’s say you closed a big client on December 30. The contract translates to $1.2 million in ARR. That’s great news for your company—add that to your current ARR of $3.8 million and you’ve got a $5 million ARR SaaS company.
Unfortunately, this revenue won’t be reported on your year-end income statement because the service your client paid for hasn’t been delivered yet. However, if you’re meeting an investor on January 10, they’ll pay lots of attention to your new deal and calculate a multiple based on your latest ARR of $5 million.
Since ARR is forward-looking and GAAP revenue is historical, both can paint a different picture of a company’s revenue growth profile.
Consider the following hypothetical information for Company XYZ:
| Year | ARR ($) | ARR Growth (%) | GAAP Revenue ($) | GAAP Revenue Growth (%) |
| 2020 | 10,000 | – | $7,500 | – |
| 2021 | 25,000 | 150 | $16,875 | 125 |
| 2022 | 55,000 | 120 | $38,812 | 130 |
| 2023 | $93,500 | 70 | $73,743 | 90 |
XYZ’s ARR growth is 25% higher in 2021, while it’s lower than GAAP revenue in 2022 and 2023. Even though deal growth slowed down in 2022, the impact of contracts signed in previous years appeared in 2022, making it your highest GAAP revenue growth year.
To summarize:
- ARR growth outpaced GAAP revenue growth in 2021, reflecting strong deal momentum.
- In 2022 and 2023, GAAP revenue growth exceeded ARR growth due to recognition of prior-year contracts.
How Subscription and Usage Revenue Shape ARR
Subscription and usage-based revenue are both key drivers of annual recurring revenue (ARR), but they impact it in different ways. Subscription revenue provides predictable ARR through fixed, recurring payments, ensuring steady cash flow.
Usage-based revenue, on the other hand, introduces variability, as it scales with customer consumption—potentially driving higher ARR growth but with less predictability. Together, they form a powerful revenue mix, balancing stability with expansion opportunities as customers increase their usage over time.
Subscription Revenue and ARR
Subscription revenue is the cornerstone of many SaaS companies’ business models. It provides predictable and recurring income that forms the backbone of Annual Recurring Revenue (ARR). ARR is a holistic metric that captures the annualized value of all recurring revenue streams, making subscription revenue a significant contributor.
What differentiates subscription revenue is its consistency. Fixed monthly or annual fees allow for straightforward forecasting and strategic planning. Because of its predictable nature, subscription revenue minimizes volatility and ensures that ARR remains a stable indicator of a company’s financial health. However, businesses must continually focus on retention and minimizing churn to protect and grow this key contributor to ARR.
Usage Revenue and ARR
Usage-based revenue adds a dynamic layer to ARR by introducing variability tied to customer behavior. Unlike subscription revenue, which is fixed, usage revenue fluctuates based on how much of a product or service a customer consumes. This variability can lead to spikes—or dips—in ARR depending on customer engagement trends.
While usage revenue enhances ARR’s potential for growth, it also introduces complexity. Companies must closely monitor customer activity and forecast usage patterns to predict how this component will contribute to ARR. The upside is significant: when paired with strong product-market fit, usage-based models can drive outsized ARR growth through expanding customer accounts. However, these fluctuations can make ARR less predictable if usage trends aren’t carefully managed.
Comparing Usage-Based ARR:
| Parameters | Usage Revenue | ARR |
| Revenue type | Variable based on consumption or usage | Fixed recurring revenue from subscriptions |
| Predictability | Unpredictable and can fluctuate month-to-month | Predictable and recurring |
| Recurrence of revenue | Non-recurring | Recurring |
Caveats to Remember
Here’s what you should remember about GAAP revenue and ARR:
- ARR is not a GAAP number: The SEC or the IRS doesn’t ask for your ARR, and you’re not required to disclose it when you file your annual return. You can choose to share your ARR in the spirit of transparency or if you want investors to look at your fast-growing ARR when you’re about to raise capital.
- Constant churn and growth assumptions of ARR are unrealistic: ARR growth may slow down because of multiple factors—new competitors may enter and saturate the market or the economy may slow down. Similarly, if better products emerge or customers don’t like your customer service, the churn rate might increase and impact future ARR.
- Investors always want ARR: Investors want a real-time picture of the company’s revenue run rate and growth trajectory because they need to project cash flows, gauge traction, and value the company using ARR multiples. They’ll also look at your GAAP revenue but will use ARR for analysis.
Best Practices to Track GAAP Revenue
Tracking ARR is fairly simple. It’s just the sum of all active subscription contracts for your product or service. However, tracking GAAP revenue can be tricky. Here are some best practices to follow to track GAAP revenue more accurately and with minimal administrative burden:
- Automate revenue tracking: Manual tracking is time-consuming. It’s also complex for SaaS companies with multi-element contracts and deferred revenue that needs to be recognized over time as per ASC 606. A system like RightRev can eliminate these problems at the source. RightRev automatically recognizes revenue according to ASC 606 guidelines. It uses a five-step revenue recognition model to comply with ASC 606, allowing your finance team to focus on strategic work that improves financial performance.
- Incorporate internal controls: Implement checks and balances to prevent errors or fraud in recording and reporting revenue. Segregation of duties, regular management reviews of revenue reports, and automated approval workflows for recognizing revenue are effective internal controls to prevent errors and fraud.
- Monitor key revenue metrics: Break down your GAAP revenue to gain more insights into your revenue. For example, you can look at revenue by performance obligation to identify your most profitable offering. Also, keep an eye on deferred revenue trends. If you expect a major dip in recognized revenue over the next year, decide on how you’ll justify this to the board or investors.
Need help tracking GAAP revenue in real time? Book a demo and experts at RightRev will help you understand how RightRev can automate and improve your revenue recognition processes.
