ARR growth: what recurring revenue says about quality

ARR growth measures how fast a company's recurring revenue grows, calculated as the annual growth rate (CAGR) on ARR — Annual Recurring Revenue. A company that has gone from 120 to 300 million kronor in ARR over three years has grown 35,7 % per year. What makes the figure interesting is not the speed but the quality pledge: recurring revenue is money contracted to come back even if the company does nothing new at all. That is why ARR growth says something about revenue quality that neither revenue growth nor any earnings multiple captures.

The formula — CAGR on the recurring base

ARR growth = (ARR_n ÷ ARR_0)^(1/number of years) − 1

where ARR0 is ARR at the start of the period and ARRn at the end of the period. ARR itself is the annualized value of all active recurring contracts: a three-year contract worth 30 Mkr counts as 10 Mkr in ARR, because it corresponds to 10 Mkr per year for three years.

One important caveat right away: ARR is a management steering metric, not an accounting post. IFRS does not define it — the companies do that themselves, in their lists of alternative financial ratios in annual and quarterly reports. Two companies can both report ARR and still be measuring different things. The definition is therefore part of the analysis, not a footnote at the bottom.

The worked example: three years, three ways to read the same development

A hypothetical software company, four measurement points:

• Year 0: ARR = 120 Mkr
• Year 1: ARR = 168 Mkr (annual growth 40,0 %)
• Year 2: ARR = 225 Mkr (annual growth 33,9 %)
• Year 3: ARR = 300 Mkr (annual growth 33,3 %)

CAGR = (300 ÷ 120)^(1/3) − 1 = 2,5^(1/3) − 1 ≈ 35,7 % per year.

Note what the average hides: the annual pace falls from 40,0 % to 33,3 %. CAGR is the honest summary of a period, but the trend in the individual years — and even more the quarterly new bookings — is what says where the company is heading. A third way to read the same numbers: at 35,7 % annual growth, ARR doubles in roughly 2,0 years (rule of 72: 72 ÷ 35,7 ≈ 2). Three readings of one and the same source — speed, direction and doubling time.

ARR is not booked revenue — the difference is timing

The accounting rules (IFRS 15) spread a subscription revenue over the period the service is delivered. The three-year agreement of 30 Mkr above gives 10 Mkr in booked revenue per year, while the difference sits as deferred revenue on the balance sheet until it is earned. The consequence: for a growing subscription company, ARR development leads booked revenue by typically one to two years. Revenue growth (V01 in AKM1) is history; ARR growth (V02) is the order book that shows up in the income statement only later. Whoever reads only the income statement is driving with rear-view mirrors — seeing what has already happened, not what is on its way in.

NRR — the silent engine behind the number

ARR growth can be split into four sources: newly signed contracts, expansion (those already paying broaden their contracts), churn (cancellations) and downgrades (contracts renewed in a smaller format). Net revenue retention — NRR — captures the last three: the share of the starting year's ARR that remains a year later, with expansion and churn included. An NRR of 112 % means the base grows 12 % per year even if the sales organization does not write a single new contract.

It is the quality difference that makes NRR important: two companies with 35 % ARR growth are not the same thing if one gets there with NRR 105 % — practically all growth is then new sales that must be replaced again and again — and the other with NRR 125 %, where the base feeds itself back. Expansion among those already paying is the cheapest growth there is, and it never shows up in a revenue chart.

Pitfall 1: the definitions drift apart

One company calculates MRR × 12. Another includes transaction revenue with the justification that it repeats. A third counts backlog — signed but not yet started assignments. No definition is wrong in itself, but they are not comparable. Always read the definitions section of the report before two ARR figures are placed side by side, and note when the company changes its definition between years — retroactive recalculation is a requirement, not a courtesy.

Pitfall 2: contracted is not automatically recurring

A five-year infrastructure contract is contracted but is not silently renewed year after year like a subscription — when it expires, the renewal stands like a cliff in the curve. Multi-year agreements with a small renewal share give high ARR growth today and broken falls tomorrow. The check: the share of ARR renewed annually versus what is bound for multiple years, and how large a part of the growth comes from occasional giant contracts.

Pitfall 3: growth bought with a discount

Aggressive pricing, long commitment periods combined with prepayment and generous introductory offers can make signed ARR rise while profitability per krona sinks. The check: follow the gross margin (V07) together with ARR growth. Growth bought at a loss shows up in the margin first — in the multiple last.

In the AKM1 model this is V02, and the variable is deliberately weighed together with V01 (revenue growth) and V12 (revenue stability): recurring revenue that both grows and stays is the combination that separates the subscription model from the project company with pretty graphics.

Rule of 40 — when growth should start paying for itself

ARR growth has a built-in temptation: it rewards speed, not profitability. The counterweight is the rule of thumb Rule of 40 — ARR growth in percent plus EBITDA margin in percent should together reach at least 40. A company with 55 % ARR growth and −15 % EBITDA margin lands on 40, exactly on the boundary, while 30 % growth and 5 % margin stops at 35. The rule of thumb is intended as a conversation, not a verdict — but the point is the trade-off: the more growth falls with the years, the more of the gap the EBITDA margin must fill, and a company whose margin improvement lags behind decelerating ARR growth carries a story that the scale does not quite pay for itself yet. In the AKM1 model, V02 is therefore weighed against V08 (EBITDA margin) and V19 (cash burn): recurring revenue that grows while the cash drains away is a matter of time, not a matter of quality.

The exercise: read the ARR chain in a real report

1. Open the latest report of a subscription company you follow and find the definition of ARR among the alternative financial ratios. 2. Note ARR today and a year ago — calculate the annual growth rate. 3. Look up NRR. If it is missing, note the absence — that is information in itself. 4. Enter the numbers in the calculator and compare ARR growth against booked revenue growth. The gap between them is future income statement on its way in.

Next steps

• Go deeper in the course ARR growth (V02): six chapters — chapter after chapter — on subscription logic, NRR and how the variable is weighted in the model.
• See the whole context in the Curriculum — V02 ties the growth block to revenue stability (V12).
• Test the impact in the portfolio builder: recurring revenue is one quality marker among twenty.

FAQ

What is ARR growth, and how does it differ from ordinary revenue growth?

ARR growth is the annual growth rate (CAGR) of recurring revenue — contracted money that comes back even if the company signs nothing new. Booked revenue spreads a subscription over the delivery period (IFRS 15), so ARR development leads the income statement by typically one to two years. Revenue growth is history; ARR growth is the order book on its way in. The ARR growth (V02) course walks through the difference chapter by chapter.

How do I calculate ARR growth with the CAGR formula?

Formeln är (ARRn ÷ ARR0)^(1/antal år) − 1, där ARR0 är startvärdet och ARRn slutvärdet. Ett bolag som går från 120 till 300 miljoner kronor i ARR på tre år har alltså vuxit (300 ÷ 120)^(1/3) − 1 ≈ 35,7 % per år. Tänk på att bolagen definierar ARR själva bland sina alternativa nyckeltal — läs definitionsavsnittet i rapporten innan du jämför två bolag, och testa egna tal i kalkylatorn.

What is NRR, and why does it matter for ARR growth?

NRR (net revenue retention) measures how much of the starting year's ARR remains one year later, with expansion, churn and downgrades included. An NRR of 112 percent means the base grows 12 percent per year without a single new contract. Two companies with the same ARR growth are therefore not the same quality: growth at NRR 105 percent rests on new sales that constantly have to be replaced, while at NRR 125 percent the base feeds itself.

What is the Rule of 40, and what does it say about ARR growth?

The Rule of 40 is a rule of thumb from the SaaS world: ARR growth in percent plus the EBITDA margin in percent should together reach at least 40. The point is the trade-off between speed and profitability — the more the growth rate falls over the years, the more the margin has to fill in. The rule is intended as a starting point for the analysis, not a verdict, and should be read together with gross margin (V07) and capital burn (V19).

This is educational financial analysis, not investment advice.