With the number of Amazon Prime member subscribers growing from 58 million in 2016 to 180 million in 2024, according to Statista, there’s a sustained recurring subscription model that one of America’s most successful retailers has increased more than 200 percent in eight years. Whether it’s a large company such as Amazon or a solopreneur beginning their recurring subscription services, it’s important to first distinguish between overall bookings and recurring revenue; and then to illustrate how businesses can measure these two types of revenue.
Dissecting Annual Recurring Revenue (ARR) and Bookings
Bookings are assurances of all anticipated earnings (recurring and one-off deals) because the business hasn’t satisfied the terms of the contracted services. Once it’s completed, the booking will turn into actual revenue. This factor is present in all sales deals, regardless of when revenue or cash will be transferred to the business from the customer. Non-recurring revenue includes training, special consulting projects, etc. (things that are one-off).
Annual Recurring Revenue (ARR) is a way to gauge recurring revenue a business projects to earn on a yearly basis. It’s quite common in eCommerce industries – be it subscriptions for food, software, etc. that are billed on a monthly or annual time frame.
How ARR Helps Businesses Analyze Operations
Businesses can determine demand trends, which help forecast recurring revenue. Lenders and investors can see how (in)efficient a company is with its marketing and sales efforts. It gives business owners and management the ability to determine customer retention and growth prospects while it provides internal and external users the ability to estimate a subscription’s worth. Additional insight businesses can gain from this metric include how much new customers add, how much renewals and upgrades impact ARR, and how churn and downgrades impact ARR.
How to Value a Company Using ARR
One common metric is Enterprise Value divided by ARR (EV/ARR), which is similar but important to distinguish from the EV/Revenue ratio. Since the ARR only factors in recurring revenue versus the EV/Revenue, which factors in all revenue regardless of the revenue recurring, the initial ratio provides a better assessment of the recurring revenue only. Assuming a company has an ARR multiple of 7 and its ARR is $15 million, the ARR has an enterprise value of $105 million.
Monthly Versus Yearly Recurring Revenue
While Monthly Recurring Revenue is not an entry on a business’s financial statements, it’s more of a key performance indicator (KPI). It’s not uncommon for companies to include it as part of their earnings releases. If a recurring subscription revenue is done monthly, it’s converted into Annual Recurring Revenue (ARR) as follows: MRR x 12 = ARR.
Recording Bookings
When a contract is signed, or an order is placed, it depends on how it’s handled. If the business receives cash prior to completing their monthly or yearly service expectation and say the contract is for $20,000 per month for 12 months, it would be recorded as follows:
Debit: Cash $240,000
Credit: Deferred Revenue $240,000
Since the contract has just been signed, but there’s been no product/service rendered, deferred or unearned, revenue has been created.
For every month that passes, the journal entry will progress as follows:
Debit: Deferred Revenue $20,000
Credit: Revenue $20,000
The deferred revenue account drops from $240,000 to $220,000, assuming the starting deferred revenue balance is even and there’s no deferred revenue.
The following month, the journal entries would be as follows:
Debit: Deferred Revenue $20,000
Credit: Revenue $20,000
This would occur every month until the end of the 12-month period.
Conclusion
When it comes to accounting for revenue, whether it’s booked, fulfilled by the company, or the payment received by the company, along with analyzing the time frame, it’s equally important to be familiar with the type of revenue it is for one to see how the company is performing.
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