Financial diligence starts by separating recurring revenue from one-off fees, bookings from recognised revenue, and invoiced amounts from cash collected.
11 min read · Level 3
I think the most useful financial diligence question is also the simplest: how much of this will happen again next year without anyone selling anything new? Everything else in the revenue line is worth something, but not the same thing, and a valuation should know the difference.
A startup's 'revenue' figure can blend several different things:
Item What it is Repeats? Recurring subscription ongoing contracted fees yes Implementation or setup one-off project fees no Usage or transaction fees variable with activity partly Bookings contracts signed, not yet delivered not yet revenue Pilots short trials, often discounted uncertain
A company reports 2,400,000 of 'annual revenue'. Diligence breaks it down:
Recurring subscriptions 1,500,000 One-off implementation fees 600,000 Signed contracts not yet started 300,000 Reported total 2,400,000
Only 1,500,000 is recurring revenue that is already being delivered. The 300,000 is bookings, and the 600,000 will not repeat unless new customers keep arriving.
Three further checks:
Recognised revenue versus invoiced amounts (deferred revenue) Invoiced amounts versus cash actually collected Revenue from related parties or unusual one-time deals
Because valuations are often set as multiples of recurring revenue. Applying a recurring-revenue multiple to one-off fees and bookings overstates the company's value.
It also changes the growth story: a company whose growth comes mainly from implementation fees is more like a services business than a software one.
Educational, not personalised financial advice. Nothing in the Investor Academy is a recommendation to buy, sell or hold anything — what is right for you depends on your own circumstances and the rules where you live.
The valuation effect.
Multiple applied to reported 2,400,000 at 8x 19,200,000 Multiple applied to recurring 1,500,000 at 8x 12,000,000 One-off fees valued at 1x 600,000 Adjusted value 12,600,000
The same company is worth about 6,600,000 less once revenue is correctly classified (19,200,000 - 12,600,000).
Accepting a single revenue figure without asking what it contains and how much of it repeats.
Separate recurring, one-off, usage-based and pilot revenue.
Identify contracts signed but not yet delivered.
Compare revenue with invoices and with cash received in bank statements.
Apply different multiples or treatment to recurring and non-recurring revenue.
Whenever a company's valuation or plan depends on its revenue figure.
Do not over-penalise implementation revenue that reliably leads to recurring contracts; judge the link with evidence.
Software companies and their auditors have repeatedly faced questions over how 'annual recurring revenue' is defined, since it is a non-standard metric not governed by accounting rules. Public companies that report it typically disclose their definition, and regulators have commented on the use of such non-standard measures.
ARR has no official definition. Always ask exactly what a company includes in it.
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