In 2022, Gartner projects that SaaS growth will rise to $140.6 billion globally. Fortunately, many measures available to SaaS companies can be used to measure and control that growth.
Not every metric will benefit your work as a sales, marketing, or management professional.
However, if your business model relies heavily on yearly subscriptions and contracts or if yours offers an enterprise-level SaaS company, you should be familiar with the terms annual contract value (ACV) and annual recurring revenue (ARR).
To help you understand why and how to compute these key metrics, we’ve broken down the definitions of annual recurring revenue (ARR) and annual contract value (ACV) in this guide. We also examine which SaaS company professionals will gain from knowing ACV and ARR and how to use them.
So, what is ACV in sales? We explain all that and more below.
What is ACV in Sales (Definition)?
The average annual contract value of your account subscription agreements is the annual contract value (ACV). The first-year ACV in a multi-year contract may be larger than later-year ACVs for SaaS businesses that additionally charge one-time fees in addition to recurring fees.
You can use the measure of the annual contract value to determine the total revenue a contract or subscription brings in overall each year.
The dollar value of each of your customer accounts, regardless of whether they involve:
- Monthly subscriptions
- Plans with different prices
- Multi-year contracts
ACV sales calculations are frequently based on the recurring revenue produced by a single customer or account. Excluding one-time fees, setup, administrative, or training fees, ACV sales calculations can be generated.
The word “ACV bookings” (the total value of accepted term contracts) is frequently used interchangeably with the term “ACV,” which, depending on your specific computations, may be the same as ACV or completely different.
How to Use ACV
There doesn’t seem to be any reliable data available to inform SaaS startups on what a typical ACV should be for their particular industry. Moreover, most of the information on what constitutes “excellent” or “poor” ACV is at best speculative because of the broad diversity of subscription models, pricing strategy, business-to-business versus business-to-consumer sales, and company-specific calculations.
Your contract amounts’ normalization by ACV enables you to:
- First, compare customer contracts of varying types or lengths.
- Then, identify the accounts that generate the most revenue value.
- Finally, better cater to individual clients, particularly those with the most promise in the long run.
For example:
- Consider that you manage a small B2B SaaS business that has recently agreed to two-year contracts with quarterly payments of $1,250 from two clients. Each of these customers has an annual contract worth $5,000 with you.
- Alternatively, suppose you’re the vice president of sales for a larger company, and you’ve signed a $180,000 deal with a new client for three years. The ACV calculation for this transaction would be $60,000.
- Lastly, a B2C company that sells access to a fitness app has 250 paying users who each pay $50 per month. So the ACV for each of these clients is $600.
The best metrics to combine with ACV are:
- Customer Acquisition Cost (CAC)
- Annual Recurring Revenue (ARR)
- Total Contract Value (TCV)
Also, check out the detailed guide about what is gross revenue.
What Can CAC and ACV Tell Us?
You may determine how quickly you “make back” the expense of acquiring a new customer by comparing your customer acquisition cost to the annual value of contracts. They represent the total price of all sales and marketing efforts necessary to bring in a customer.
Consider acquiring five new clients with a $5,000 ACV. However, your CAC to ACV ratio is 1.6 because of the $8,000 average CAC of these contracts. To put it another way, it takes nearly two years (1.6 years, or more than 19 months) to recoup the expense of acquiring a new client.
What is ARR (Definition)?
ARR is the value of recurring revenue of a business’s term subscriptions normalized to a single calendar year. How does that appear on paper? Let’s imagine that Donovan pays Tyrone $40,000 for a four-year subscription to a business service. Our ARR would be $10,000 if we normalized the full-term revenue to a single year because that is the yearly revenue from that subscription.
Calculations for ARR:
- Every year, calculate the total dollar amount of your recurring revenue.
- Never consider one-time fees or costs.
- Let’s calculate your income at a specific moment.
It displays the amount of money SaaS businesses anticipate generating year after year and, unlike ACV, is a statistic accepted by the whole industry.
How to Use ARR
ARR is a reliable indication of financial health because it quantifies predictable annual revenue. Additional uses for it include:
- Track revenue growth over time.
- Identifying income swings due to subscription renewals, upsells, or cancellations will help you forecast revenue.
- Improve your customer retention, marketing, and sales strategy by analyzing the data.
ACV vs. ARR: The Difference
Despite these significant distinctions, ACV and ARR are sometimes mistaken since they represent annualized contract values.
The primary difference when comparing ARR with ACV is that ACV typically measures a single account over multiple years, whereas ARR measures multiple accounts simultaneously.
Consider that you currently have three customers as a simple example.
- Customer X has an annual subscription plan worth $1,000, making their ACV $1,000.
- Customer Y’s annual subscription plan is $1500; their ACV is $1500.
- Customer Z’s annual subscription plan is $2,000; their ACV is $2,000.
Your ARR is $4500 ($1000 + $1500 + $2000).
Organizations may interpret these metrics differently, notably ACV (SaaS companies don’t view ACV as a standardized metric).
Here is a brief breakdown of their key distinctions:
How to calculate ACV and ARR
Just keep in mind that as long as everyone involved is on the same page and calculates ACV and ARR in the same way, it’s acceptable if your company or sales department interprets these metrics slightly differently than other organizations.
How to Calculate ACV (Annual Contract Value)
Here’s the standard formula for calculating ACV for a single account.
ACV = Total contract value ÷ Number of years
Some businesses employ ACV inventive ways to make some data simpler to observe and understand.
Here is a straightforward method you may use as an illustration to calculate the average ACV of a multi-year contract.
Average ACV = Total ACV of contracts ÷ Number of contracts
Examples:
For a single account:
To calculate ACV would seem as follows: if “Customer A” signs a three-year annual subscription contract with a $1500 contract total value.
ACV = $1500 ÷ 3 = $500
The ACV calculation would be as follows if “Customer B” signs a five-year, $4500 contract for a more expensive subscription plan.
ACV = $4500 ÷ 5 = $900
But what if “Customer C” decides to sign a two-year, $100 per month membership contract? Here’s how you may normalize the customer’s contract over a year using the ACV formula.
$100 per year multiplied by 12 months is $1200.
The total contract value (TCV) is $1200 divided by two years, or $2400.
ACV = $2400 ÷ 2 = $1200
By this point, it should be obvious why the question “what is ACV in sales?” is “an easy way to compare different recurring income account types.”
Total Contract Value (TCV)
To determine the total value of multi-year contracts (this could be yearly contracts or subscriptions with a termination period, but ongoing subscriptions with no defined end are not included), TCV (Total Contract Value) is determined.
To Calculate ACV across multiple contracts:
There are several applications for calculating ACV. Let’s examine both.
Approach 1
You determine the ACV for each account separately, then combine those sums and enter the total into the calculation above.
- ACV for customer A is $1000.
- ACV for customer B is $2000.
- ACV for customer B is $6000.
Contracts’ total ACV is $9,000 ($1000 + $2000 + $6000).
Average value of ACV = $9000 / 3 = $3000
On the other hand, it might be simpler to batch your computations if you’ve signed numerous clients with various contract terms.
Approach 2
Let’s imagine you want to discover your average ACV for all ten accounts. You presently have ten customers with various subscription contracts.
- Two of them have one-year deals at $30,000 each.
- Five have contracts for three years worth $60,000 each.
- Three have contracts of $100,000 each for five years.
You would first compute the ACVs for each contract in a batch.
ACV = $30,000 / 1 year = $30,000 x 2 contracts = $60,000
ACV = $60,000 / 3 years = $20,000 x 5 contracts = $100,000
ACV = $100,000 / 5 years = $20,000 x 3 contracts = $60,000
The total ACV for all of your contracts would then be added up.
Total ACV is equal to $220,000 ($60,000 + $100,000 + $60,000).
Then you would enter that outcome into your formula.
Average value of ACV = $220,000 / 10 = $22,000
How to Calculate Annual Recurring Revenue (ARR)
There are two ways to calculate ARR: a quick, simple method and a more precise, conventional method.
By deducting your non-recurring income from your annual revenue for the preceding year, you can easily calculate your ARR.
ARR = Total annual revenue – Non-recurring revenue
This will provide you with a short overview of how your ARR seems. However, this ARR formula does not account for potential changes in client subscriptions over time.
Since they might not have enough data to work with, SaaS enterprises in their first year of operation may utilize the annual run rate instead of yearly recurring income to construct revenue estimates.
The standard formula for computing ARR is shown below:
ARR = ARR at the beginning of the year + ARR gained from new customers + ARR gained from subscription upgrades – ARR lost to subscription downgrades – ARR lost to customer churn
On January 1st, let’s imagine you have 100 client subscriptions, each generating $1200 in recurring revenue.
Your ARR would remain the same as your yearly revenue from the prior year, or $120,000 (100 x $1200) if nothing changed during the following months (assuming you didn’t have any non-recurring revenue).
However, as the year progresses, suppose your business:
- Receives 20 new $1200 memberships from customers (20 x $1200 = $24,000)
- 10 existing customers are upsold to $1800 memberships (10 x $600 = $6000).
- Has 10 current clients drop to $800 subscriptions (10 x $400 equals $4000).
- 3 current clients cancels their subscriptions (3 x $1200 = $3600)
You might incorporate these occurrences as they happen into your algorithm to calculate your ARR in real-time.
ARR = $120,000 + $24,000 + $6000 – $4000 – $3600 = $142,400
The formula above can be used to determine your MRR (monthly recurring revenue), which you can multiply by 12 to determine your ARR value if your business primarily relies on monthly membership fees.
Adding in Onboarding, Training, and Implementation Fees
There are many ways to frame this, and the optimal one for your company will ultimately rely on how you bundle your agreements, how specific you want to be, and how you want to frame this in general.
For instance:
- Customer A agrees to a one-year, $1000 per year payment schedule made up of monthly payments for onboarding.
- Customer B accepts a two-year, yearly payment schedule of $750, including an implementation fee and training fee.
Tools to Help Analyze Your Metrics
You’ll be relieved to learn that analytics tools are available to make your job more straightforward if you’re feeling a little intimidated by the thought of altering ACV, ARR, and other revenue indicators.
A CRM like Sloovi may show your real-time sales data for an unparalleled perspective of your company’s performance. Check out the guide about customer acquisition costs.
Who Needs to Use ACV and ARR?
Who may profit from knowing what ARR and ACV mean? Most B2B companies with a subscription model, startups, and SaaS sales, marketing, and management experts, including:
- Customer sales reps and sales managers
- Directors of Sales and VP of Marketing
- CEOs, CFOs, CSOs, and other C-suite executives
Other Metrics
Customer Lifetime Value
Understanding the hypothetical lifetime value connected to a particular account, also referred to as CLTV, LCV, and LTV can help your marketing strategy and retention strategy. All you need to do is extrapolate an average or high-value client’s ARR across the anticipated lifespan of your company.
ACV Bookings
In the same way, as TCV measures the entire contract or revenue value represented by confirmed subscriptions, ACV Bookings only considers subscriptions with one-year or open-ended contracts. Therefore, as part of your sales reporting, you would use TCV to evaluate and contrast accounts for more lengthy, closed contracts.
Sloovi and Your Sales Process
Using a CRM platform to cross-sell, upsell, adjust subscription costs, and measure your ACV sales performance, you may utilize the data you collect from tracking recurring income.
With Sloovi, you can keep track of all your subscriptions and recurring clients, create distinct recurring revenue streams, and view the increase in recurring income payments that have been made or canceled.
Start controlling your revenue with Sloovi today!