According to Gartner, SaaS growth is expected to reach $140.6 billion worldwide in 2022. Fortunately, SaaS companies are fairly spoiled for choice when it comes to metrics that can help measure and manage that growth.
Not every metric is going to add value to your role as a sales, marketing or management professional.
But if yours is an enterprise-level SaaS company, or you deal predominantly in yearly subscriptions and contracts, ACV (annual contract value) and ARR (annual recurring revenue) are two terms you should know.
In this guide, we break down both what ARR means and the ACV meaning individually to show you why these metrics are important and how to calculate them. We also look at which SaaS professionals will benefit from understanding ACV and ARR, and how you can put them to work.
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What is ACV?
ACV (annual contract value) is a metric that shows you how much an ongoing customer contract is worth by averaging and normalizing its value over one year.
You can use ACV to measure the dollar value of all your customer accounts, whether they involve:
- Monthly subscriptions
- Differently priced plans
- Multi-year contracts
ACV sales calculations are typically based on the recurring revenue generated by a single client or account and don’t normally include initial or one-time setup, training or administrative fees.
How to use ACV
Because ACV normalizes your contract amounts, you can use it to:
- Compare customers whose contracts differ in type or duration
- Discover which accounts provide the greatest revenue value
- Better service individual clients, especially those with the greatest long-term potential
To help clarify the question of what is ACV in sales specifically, here’s a simple use case example.
Let’s say you’ve recently closed multiple subscription-based deals, involving different periods of time and different dollar amounts, and you’d like a quick estimate of your annual sales. ACV can help you calculate the average, normalized revenue value of every contract you initiate.
Now that we have a handle on ACV meaning, let’s look at the revenue-driven metric that many consider its counterpart.
What is ARR?
ARR (annual recurring revenue) is a metric that shows you the amount of recurring income you’re generating from all your subscription accounts.
- Measure the total dollar value of your recurring revenue on an annual basis
- Do not take one-time fees or charges into account
- Let you measure your revenue at a given point in time
How to use ARR
Because it measures predictable annual income, ARR is a good indicator of financial health. You can also use it to:
- Track revenue growth over time
- Pinpoint income fluctuations from subscription renewals, upsells or cancellations
- Analyze and improve your sales, marketing and retention strategies
If your SaaS company deals in monthly subscriptions, you may also want to measure MRR (monthly recurring revenue). Multiplying MRR x 12 will give you your ARR value.
ACV vs ARR: What’s the difference?
Since ACV and ARR both measure annualized contract values, they’re easily confused despite some key differences.
The biggest distinction when considering ARR vs ACV is that ACV is generally used to measure a single account across multiple years, while ARR measures multiple accounts at the same time.
As a simple illustration, imagine you currently have three customers.
- Customer X is on a $1000 annual subscription plan, so their ACV is $1000
- Customer Y is on a $1500 annual subscription plan, so their ACV is $1500
- Customer Z is on a $2000 annual subscription plan, so their ACV is $2000
Your ARR, meanwhile, is $4500 ($1000 + $1500 + $2000).
In practice, these measurements may be used in different ways by different companies – especially ACV (SaaS companies don’t consider ACV to be a standard metric).
We’ll take a closer look at how ACV and ARR are typically calculated in the next section. But in the meantime, here’s a brief summary of the main differences between them.
How to calculate ACV and ARR
Remember, it’s okay if your company or sales department interprets ACV or ARR slightly differently from other organizations so long as everyone involved is on the same page, and calculates them in the same way.
How to calculate ACV
Here’s the standard formula for calculating ACV for a single account.
ACV = Total contract value ÷ Number of years
If, for example, Customer A signs a three-year annual subscription contract with a total value of $1500 the ACV calculation would look like this.
ACV = $1500 ÷ 3 = $500
If Customer B commits to a more expensive subscription plan on a five-year contract worth $4500, the ACV calculation would look like this.
ACV = $4500 ÷ 5 = $900
But what happens if Customer C opts for a two-year, monthly subscription contract at $100 per month? Here’s how you could use the ACV formula to normalize the customer’s contract over one year.
Annual subscription rate = $100 x 12 months = $1200
Total contract value = $1200 x 2 years = $2400
ACV = $2400 ÷ 2 = $1200
It should be clear now why the answer to “what is ACV in sales?” is “a quick way to compare various types of recurring revenue accounts”.
Calculating ACV across multiple contracts
Some companies find creative ways to use ACV to make certain data easier to view and digest.
For example, here’s a simple formula you could use to gauge the average ACV of multiple contracts.
Average ACV = Total ACV of contracts ÷ Number of contracts
There are a couple of ways you can put this calculation to work. Let’s look at both.
With this method, you calculate the ACV for each of your accounts individually, then add those amounts together and plug the result into the formula above.
- Customer A has an ACV of $1000
- Customer B has an ACV of $2000
- Customer B has an ACV of $6000
Total ACV of contracts = $9000 ($1000 + $2000 + $6000)
Average ACV = $9000 ÷ 3 = $3000
If, on the other hand, you’ve signed a lot of customers with a wide range of contract terms, it can be easier to batch your calculations.
Let’s say you currently have ten customers with different subscription contracts, and you want to know your average ACV for all ten accounts.
- Two are on one-year contracts worth $30,000 each
- Five are on three-year contracts worth $60,000 each
- Three are on five-year contracts worth $100,000 each
First, you’d batch-calculate the ACVs for each contract.
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
Next, you’d tally the total ACV for all your contracts.
Total ACV = $60,000 + $100,000 + $60,000 = $220,000
Finally, you’d plug that result into your formula.
Average ACV = $220,000 ÷ 10 = $22,000
By performing this calculation, you’d essentially discover that each of your customer contracts is worth $22,000 on average this year. Next year, however, if your one-year contracts don’t renew, or if you acquire additional clients, your average ACV will be different.
It’s worth noting that there’s no industry benchmark for ACV, since high or low results are neither good nor bad. That’s why ACV offers the most value when you team it up with other revenue or sales metrics, like ARR.
How to calculate ARR
There’s a fast, easy method for calculating ARR and the standard, more accurate method.
The simplest way to determine your ARR is by subtracting your non-recurring income from your annual revenue for the previous year.
ARR = Total annual revenue – Non-recurring revenue
This will give you a quick, general idea of what your ARR looks like. What this formula doesn’t take into account, however, is how customer subscriptions may have changed in the meantime.
Here’s the standard formula for calculating ARR.
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
Let’s say you have 100 annual customer subscription contracts on the first day of January, each yielding $1200 in recurring revenue.
If nothing changed over the coming months (and assuming you didn’t have any non-recurring revenue), your ARR would remain equal to your total annual revenue from the previous year - or $120,000 (100 x $1200).
As the year unfolds however, let’s say your company:
- Gains 20 new $1200 customer subscriptions (20 x $1200 = $24,000)
- Upsells 10 existing customers to $1800 subscriptions (10 x $600 = $6000)
- Has 10 existing customers downgrade to $800 subscriptions (10 x $400 = $4000)
- Has 3 existing customers cancel their subscriptions (3 x $1200 = $3600)
To determine your ARR in real time, you could plug these events into your formula as they occur. In this example, overall results indicate that, with new and upgraded contract amounts outweighing downgrades and churn, your company is on a positive growth trend.
ARR = $120,000 + $24,000 + $6000 - $4000 - $3600 = $142,400
If your company works mostly with monthly subscription fees, you can calculate your MRR (monthly recurring revenue) following the same formula described above, then multiply that result x 12 to arrive at your ARR value.
Tools to help analyze your metrics
If you’re feeling a little overwhelmed by the idea of manipulating ACV, ARR and other revenue metrics, you’ll be pleased to know that analytics tools exist to make your job easier.
With Plecto, for example, you can display your real-time sales data inside a CRM like Pipedrive for an unbeatable overview of your business performance.
Pipedrive’s recurring revenue feature, meanwhile, makes it easy to:
- Track all your subscriptions and repeat customers
- Set up separate recurring revenue streams
- View the growth in new or canceled recurring revenue payments
Tracking recurring revenue with the help of a CRM tool gives you a solid foundation of data you can use to upsell, cross-sell or measure your ACV sales results.
Who needs to use ACV and ARR and what for?
Who can benefit from understanding terms like ARR and ACV? SaaS sales, marketing and management professionals, for the most part, including:
- Customer sales representatives and sales managers
- VP of Marketing and Director of Sales
- CEOs, CFOs, CSOs and other C-suite executives
Let’s take a brief look at how various team members might use these metrics.
As a sales rep, you can use ACV to recognize the accounts most likely to benefit from your timely attention.
If you identify low or high-value clients, for example, or accounts nearing the end of their term, you might:
- Get in touch with add-on product or service suggestions
- Initiate a retention strategy
- Negotiate a contract extension
As mentioned earlier, you can also use ACV to ballpark and track your annual sales income.
Sales and marketing managers
As a manager, you can benefit from teaming metrics like ACV and ARR with a host of sales dashboard templates to:
- Monitor your team’s performance
- Tweak your training efforts
- Make more profitable decisions or department recommendations
By using recurring revenue measurements in conjunction with a metric like CAC (customer acquisition cost), for example, you can compare account values against the cost to acquire them and reevaluate your strategies, spend and resources.
Plus, because ARR is considered a measure of company size, it’s a great way for your marketing team to keep an eye on the competition and track your growth against theirs.
As someone who helps oversee company finances, you can use year-over-year ARR comparisons to improve the timing and projections around:
- Annual budgets and revenue forecasts (as in financial services forecasting, for example)
- Large capital expenditures
- Hiring of additional staff
Staying on top of your ARR metrics can even help you see when a new cash injection, whether in the form of a loan or investment, may be the right course of action.
Other similar terms: TCV (Total Contract Value), AOV (Average Order Value) and more
To further clarify their role, here are a few more SaaS metrics that are either similar or complementary to ACV and ARR.
TCV (Total Contract Value)
Rather than averaging and normalizing across a single year, TCV measures revenue value across an entire contract. If, for example, Customer X is on a five-year contract at an annual rate of $200, the ACV would be $200, while the TCV would be $1000 (5 x $200). Unlike ACV, TCV includes one-time and recurring contract charges or fees. It’s mainly used to compare the value of clients on multi-year contracts.
Like TCV, ACV Bookings are a measure of the total contract or revenue value represented by confirmed subscriptions, but only those involving one-year or open-end contracts. For longer, closed contracts, you would use TCV to analyze and compare accounts as part of your sales reporting.
MRR (Monthly Recurring Revenue)
Many SaaS companies, including those with annual contracts, use MRR to investigate their predictable revenue stream as a monthly value. Using MRR to analyze performance across different subscription terms can make it easier to manage monthly cash flow and customer retention.
AOV (Average Order Value)
AOV offers another way to take a quick measure of the average value of your revenue-generating subscription contracts. By dividing your ARR by the number of contracts or customers you currently have, you can better assess your pricing strategies and their impact on revenue growth.
CLV (Customer Lifetime Value)
Also known as CLTV, LCV and LTV, understanding the theoretical lifetime value associated with a specific account can inform both your marketing plan and retention approach. All you have to do is project the ARR for an average or high-value client over the expected life of your business.
Now that you have a good idea of what lies behind a company’s ARR and ACV meaning, you’re sure to find lots of ways you can use these two metrics to improve personal and team performance.
To help inspire you to action, here are three key areas that are likely to benefit from regular revenue measurement:
- Sales strategy and customer success
- Product development and marketing processes
- Future planning and investment decisions
No matter what role you play as a SaaS professional, the better you understand the results that you and your team are generating, the better control you can have over their impact.