For SaaS companies, Annual Recurring Revenue (ARR) is one of the most important metrics for measuring predictable revenue and long-term business health. It’s often the foundation for valuation, growth targets, and investor communication.
But as more SaaS businesses shift toward usage-based pricing models, defining ARR isn’t as straightforward as it once was. In a model where customers are charged based on consumption, what exactly counts as “recurring”?
A well-defined ARR framework provides clarity in forecasting, valuation, and financial reporting. For management teams and investors, understanding the recurring base of the business — separate from variable growth — is critical for assessing revenue quality and long-term scalability.
The Traditional Definition of ARR
In a fixed fee subscription-based model, ARR is relatively simple:
ARR = Monthly Recurring Revenue (MRR) × 12
MRR includes all subscription fees that recur each month — such as per-seat licenses or flat platform fees. These revenues are contractual, predictable, and renewable.
The Challenge with Usage-Based Revenue
In usage-based models, customers are billed based on consumption metrics like data volume, API calls, active users, or transaction counts. This creates variability month to month, even among long-term customers.
For example, a customer may pay a $2,000 base fee per month plus variable fees tied to usage. Some months, the total bill may be $3,500; others, $4,200. The question becomes: should all of that usage-based revenue be included in ARR?
A Practical Framework for Usage-Based ARR
The key is distinguishing committed recurring revenue from variable usage revenue:
Committed ARR
Include all recurring contractually committed amounts — such as annual platform fees, per-seat minimums, or committed spend tiers. These revenues are predictable and align with the original intent of ARR.
Usage ARR
It may not be a best practice to include usage-based revenue in your ARR metrics. By definition, usage-based revenue is not recurring in nature from month to month and it may distort other SaaS metrics like net revenue retention (NRR). In this case, usage-based revenue should be tracked separately and excluded from your ARR computations.
However, if SaaS operators feel it is necessary to include usage-based revenue in their ARR metrics, different types of methodologies may be used to normalize a repeatable and defensible pattern. This is especially true when customers’ consumption has stabilized or grown predictably over time.
Exclusions
Avoid including one-time fees, onboarding or overage spikes in ARR. These do not reflect the ongoing recurring value of the customer relationship.
Reporting Clarity: Contracted vs. Total ARR
Many SaaS companies now disclose two complementary metrics:
Contracted ARR (CARR): The total annualized value of signed recurring commitments.
Total ARR: Includes both contracted and recurring usage revenue that has become stable and predictable.
This dual approach helps investors and stakeholders distinguish between guaranteed recurring revenue and recurring-like revenue driven by customer behavior.
Why It Matters
There’s no single “correct” way to define ARR in a usage-based business model. Whether you adopt a conservative committed ARR approach or include normalized usage revenue, the key is consistency. Choose a methodology that reflects your business reality, document it clearly for stakeholders, and apply it uniformly across reporting periods. Your investors care less about which approach you choose and more about whether they can trust your numbers quarter over quarter.
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About Herod CPA PLLC
Herod CPA PLLC helps venture-backed SaaS companies build defensible metrics frameworks and financial reporting that investors trust. Whether you’re transitioning to usage-based pricing or preparing for your next funding round, we ensure your ARR methodology can withstand board-level scrutiny.
Navigating ARR definitions for your business? Let’s talk.
Contact us at info@herod.cpa or follow us on LinkedIn for more information.