Software and Subscription Metrics
What recurring revenue, retention, billings, and customer acquisition figures mean, how they connect to the audited statements, and how to test numbers that companies define for themselves.
The short version
Subscription companies are valued largely on figures that don't appear in their financial statements: annual recurring revenue, retention rates, billings, and the cost of winning a customer. They exist because the statements lag. A subscription sold today becomes revenue over the next year, so the accounts understate a company that's growing and overstate one that's stalling. The metrics fill that gap, but each company defines its own, and nobody audits them the way the statements are audited. The discipline is to learn the definitions, tie the metrics back to revenue, deferred revenue, and cash, and adjust for costs the favoured measures leave out, such as stock-based compensation.
By the end of this lesson, you'll be able to
- Define annual recurring revenue, gross and net revenue retention, billings, and remaining performance obligations
- Reconcile a year's change in recurring revenue and connect it to reported revenue
- Test company-defined metrics against the audited statements
Why this matters
A software company that sells subscriptions can report a loss for years and still be a good business, or report growth and be quietly failing. The ordinary statements don't easily show which. That's why these companies, and the investors who follow them, rely on a separate set of measures. Because those measures drive valuations, they also get stretched. This lesson explains the main ones and how to check them.
Why the statements lag
Under the rules in Revenue Recognition, a one-year subscription sold in December adds one month of revenue to this year. The cost of winning that customer, mostly sales pay and marketing, is largely spent up front. So a company growing quickly reports heavy costs today for revenue that arrives later. Its losses can be a sign of success. The metrics below try to show the underlying position.
Recurring revenue
Annual recurring revenue (ARR). The yearly value of a company's subscriptions in force on a given date. It's a snapshot defined by each company, not a figure from the audited financial statements. Glossary, or ARR, is the yearly value of the subscriptions in force on a given date. It's a snapshot of the run rate, not revenue for any period. It changes for four reasons, and a good company reports each one.
| Amount | |
|---|---|
| ARR at the start of the year | 100 |
| New customers | +30 |
| Existing customers buying more | +15 |
| Existing customers buying less | (2) |
| Customers who left | (8) |
| ARR at the end of the year | 135 |
ARR grew 35%. Revenue for the year will be somewhere between the opening and closing figures, since the new subscriptions were sold at different times. Here it's $118 million.
Retention
Two rates describe what happened to the customers the company already had. Both look only at the $100 million that existed at the start.
- Gross revenue retention counts only losses: ($100 million − $2 million − $8 million) ÷ $100 million, or 90%. It can't be above 100%.
- Net revenue retention. Recurring revenue from the customers a company had a year ago, including what they added and after what they cut or cancelled, as a percentage of what they were paying then. Glossary also counts what existing customers added: ($100 million − $2 million − $8 million + $15 million) ÷ $100 million, or 105%.
Net retention above 100% means the company would grow even if it never signed another customer. It's a powerful figure, and it can hide a problem. A company could lose a fifth of its customers every year and still report net retention above 100% if the ones who stay buy much more. Gross retention shows the leak. Ask for both.
Billings, deferred revenue, and what's still owed
Three figures connect the metrics to the audited statements.
- Deferred revenue is on the balance sheet: amounts invoiced for service not yet delivered.
- Billings is what the company invoiced in the period. It isn't in the statements, but it can be calculated: revenue plus the change in deferred revenue. If Company S's deferred revenue rose from $40 million to $52 million, its billings were $118 million + $12 million, or $130 million.
- Remaining performance obligations are in the notes. Companies must disclose the amount of contract value allocated to promises they haven't yet fulfilled.1 For a subscription company this is roughly the total of signed contracts not yet recognized as revenue, including years that haven't been invoiced.
Billings growing faster than revenue suggests growth is speeding up. Billings growing more slowly suggests it's about to slow. Be careful with changes in contract terms, though. A company that moves customers from monthly to annual invoicing gets a one-time jump in billings and cash with no change in the business.
The rest of this lesson is for members
Still to come in this lesson: The cost of growth, Profit measures to adjust, Testing metrics the company defines itself, the key takeaways, and 2 quiz questions with explanations.
Membership opens every lesson in the curriculum, the capstone projects, the interactive tools, and the members-only channels in the Hyperion Entities Discord. The first lesson of every module stays free.
Go deeper
- Energy and Commodity ProducersFinancial Statement Analysis in Depth (depth track)
- Stock-Based CompensationFinancial Statement Analysis in Depth (depth track)
- Revenue RecognitionFinancial Statement Analysis in Depth (depth track)
- GAAP and Non-GAAP NumbersPart 4: Research and Valuation
Notes and sources
- Financial Accounting Standards Board. Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606). Checked 2026-10-11. Back to text
- U.S. Securities and Exchange Commission. Commission Guidance on Management's Discussion and Analysis of Financial Condition and Results of Operations (Release No. 33-10751, January 30, 2020). Checked 2026-10-11.