What is the difference between ARR and revenue?

A founder tells an investor the company is at ₹8 crore ARR. The investor asks for the last audited financials, which show revenue of ₹5.6 crore. Nothing improper has happened, and the next forty minutes are spent explaining the gap.

It is a conversation worth being ready for, because the gap is real, the explanation is straightforward, and a founder who cannot give it quickly loses credibility over an accounting distinction rather than over the business.

The two numbers measure different things. Confusing them is the most common self-inflicted wound in an early-stage software diligence.

What each one is

ARR is a run rate. It takes the contracted recurring revenue in force at a single moment and annualises it: if every customer you have today kept paying exactly what they pay today for a year, this is what it would come to.

It is a forward-looking snapshot. It has no period, it is not an accounting measure, no standard defines it, and it does not appear in any set of financial statements.

Revenue is backward-looking and measured over a period. It is what you earned in the twelve months to March, recognised as you delivered the service rather than as you billed for it. It is defined by accounting standards, it appears in your audited accounts, and your auditor has an opinion about it.

ARR is a photograph of today. Revenue is a record of the year. In a growing business they are never the same number, and the difference is not an error.

Why they differ, even when both are right

Three reasons, and the first is the largest.

Growth and timing

ARR reflects the customers you have at the end of the period. Revenue reflects what each customer paid for the portion of the period they were actually a customer.

A customer signed in February at ₹12 lakh a year adds ₹12 lakh to ARR immediately. In the financial year ending March, they contributed about ₹2 lakh of revenue. Multiply that across a year of growth and closing ARR sits well above the revenue for the year that produced it. The faster you grew, the bigger the gap.

Non-recurring revenue

Implementation fees, training, customisation and one-off professional services are genuine revenue and belong in the P&L. They are not recurring and do not belong in ARR. So revenue includes things ARR excludes, pushing in the other direction.

Recognition

An annual contract billed upfront in January is cash in January and revenue spread across twelve months. The unearned part sits on the balance sheet as deferred revenue. ARR ignores all of this, because it is a run rate rather than a recognition measure.

A worked reconciliation

Illustrative figures for a fictional company with a 31 March year end. Every number is invented.

• ·Closing ARR at 31 March: ₹800 lakh.
• ·Less the timing effect, because much of that ARR was signed during the year rather than at the start. Revenue from subscriptions for the year was ₹560 lakh, so the timing effect is ₹240 lakh.
• ·Add non-recurring revenue: implementation and training fees of ₹64 lakh, which are in revenue and not in ARR.
• ·So recognised revenue for the year is ₹624 lakh, against closing ARR of ₹800 lakh.
• ·Then to cash: ₹96 lakh of annual contracts were billed in advance and not yet earned, which sits in deferred revenue, and ₹112 lakh of invoices were unpaid at the year end. Cash collected was ₹608 lakh.

Four different numbers describing the same year: ₹800 lakh, ₹624 lakh, ₹608 lakh, and a deferred balance of ₹96 lakh. All four are correct and each answers a different question. The founder who can walk an investor through that chain in two minutes has demonstrated something useful about how the company is run.

What inflates ARR, and what diligence removes

Reported ARR is higher than the revenue base can support in a large share of software diligences. Almost always for the same handful of reasons.

1. 01One-off fees counted as recurring. Implementation, setup, training, migration and customisation. The single most common adjustment.
2. 02Pilots and trials counted as contracted. A paid pilot with no commitment beyond three months is not annual recurring revenue, however likely it is to convert.
3. 03Customers who have given notice. Still paying, and their ARR is leaving. Diligence removes it and so should you.
4. 04Usage above a committed minimum, annualised. If a customer's contract commits them to ₹10 lakh and they consumed ₹16 lakh last month, the committed figure is what is contracted. The rest is real, valuable and not contracted.
5. 05Verbal commitments and signed letters of intent. Not revenue of any kind until there is a contract.
6. 06Annualising a good month. Taking the best month of the year and multiplying by twelve is a run rate of sorts and it is not ARR, and presenting it as such is the version of this that damages trust rather than just costing an adjustment.

The pattern is worth noticing: every one of these makes ARR look better. Diligence teams know the list, they check it in the first week from raw billing data, and finding two or three of them changes the tone of the whole process.

Getting the definition right, and then leaving it alone

The most useful thing a company can do here costs an afternoon. Write down what counts as ARR, in a paragraph, with the exclusions listed. Then stop changing it.

A reasonable definition: the annualised value of contracted, recurring subscription fees from customers who are active and have not given notice, measured at a point in time, excluding one-off fees, professional services, usage above committed minimums, taxes and any contract not yet signed.

Two disciplines follow. Report the same definition every month, so the series means something. And when a genuine change is needed, restate the history alongside it rather than applying the new definition from this month forward, which is how a metric quietly becomes unusable.

It is also worth deciding how you handle a few specific cases in advance, because they will come up: multi-year contracts with price escalations, contracts in a foreign currency, monthly customers with no commitment, and customers on a temporary discount. None has a single right answer. All of them need a consistent one.

The currency question, for Indian companies

Indian software companies selling internationally frequently report ARR in dollars and revenue in rupees, which adds a fourth reason the two numbers do not tie.

The practical approach is to fix a rate for the reporting period and state it, rather than translating each month at the prevailing rate and letting the currency move your ARR. An ARR figure that fell because the rupee strengthened tells the reader nothing about the business.

Report both, name the rate used, and keep the rate fixed for at least a financial year. If a material share of revenue is in dollars, the rate assumption also belongs in your model, because it moves margin as well as revenue.

Deferred revenue, and why it is a good sign

The gap between billing and earning sits on the balance sheet as deferred revenue, and founders often read it as a liability to worry about. It is a liability in the accounting sense and it is usually good news.

A large deferred revenue balance means customers have paid in advance for service you have not yet delivered. They gave you cash early, which funds the business at no cost, and they committed to a year rather than a month. Software companies with healthy annual prepayment carry a big deferred balance and it is a strength.

Two things to watch. It is real revenue you still owe delivery on, so it cannot be spent as though the work were done. And a falling deferred balance while ARR rises means customers are moving from annual to monthly billing, which is a cash story that the ARR line will not show for another year.

It is worth reporting the deferred balance in the monthly pack alongside ARR and revenue. Three numbers, and together they describe growth, recognition and cash commitment in a way no single one does.

Multi-year contracts and the annualising trap

A three-year contract worth ₹60 lakh in total is ₹20 lakh of ARR, not ₹60 lakh. That sounds obvious and it is a mistake made regularly, usually in a pitch deck rather than in the accounts.

Escalations complicate it. If the same contract is ₹18 lakh, ₹20 lakh and ₹22 lakh across the three years, the ARR today is ₹18 lakh, and it will step up on the anniversary. Booking the average, or the final year, overstates the run rate now.

The related figure worth knowing is total contract value, which is the whole ₹60 lakh. It is a genuinely useful number for a business selling multi-year deals, and it is a different number with a different name. Reporting TCV as ARR is the kind of thing that gets found and remembered.

The safe convention: ARR is what the customer is contracted to pay over the next twelve months at today's rate. Anything further out is a separate disclosure.

Which number to use where

• ·Investor updates and pitch decks: ARR, clearly labelled, with the definition available. It is what investors compare across companies and it is the right measure of current scale.
• ·Board packs: both, with the reconciliation. A board should see the run rate and the recognised revenue, because the gap between them is information about growth and mix.
• ·The annual operating plan and the budget: recognised revenue. You cannot budget costs against a run rate, because the run rate is not what arrives.
• ·Cash forecasting: neither. Use expected collections, which is a third thing again and the only one that pays salaries.
• ·Statutory accounts and tax: recognised revenue, on whatever basis your auditor and your CA agree is correct. ARR has no place here at all.

What to do this quarter

1. 01Write your ARR definition down in one paragraph, with the exclusions named.
2. 02Test it against the list above, honestly. If any of the six inflations apply, fix the number now rather than in diligence.
3. 03Build the reconciliation from closing ARR to recognised revenue to cash collected, for the last completed year.
4. 04Put closing ARR and recognised revenue side by side in the monthly pack, so nobody in the company confuses them either.
5. 05Then run the ARR bridge, which is the next question an investor asks: not how large the ARR is, but how much of it you had to buy. The ARR bridge calculator on this site does that in a minute.

None of this makes the business better on its own. What it does is remove a category of problem entirely, so that a diligence conversation is about the company rather than about the definitions.

About Simplify

Simplify is a finance clarity and investment readiness practice working with founders across India, built on six years inside startups. We write about the questions founders bring before a decision, not after it.