ACV vs. ARR : A Guide for SaaS Companies

The SaaS growth has already exceeded $176.62 billion- growing 16% in just one year. Expectantly, in 2023, the SaaS market value will reach $208.1 billion. Experts are also hoping for a 17.5% increase in SaaS revenue in the coming years.

Now, SaaS companies have multiple options to choose from, when it comes to the metrics for measuring growth and managing it. However, not all metrics can add value to the departments like sales, management, or marketing. But if your business model provides yearly subscriptions and contracts or it is a big SaaS company- you should know about annual contract value (ACV) and annual recurring revenue (ARR).

In this piece, we are discussing ACV and ARR individually, their respective differences, and how these metrics influence your business growth.

What Is ACV?

The annual contract value is one of the key metrics to show the worth of a potential customer contract- by normalizing and averaging the value of the contract over one year. With ACV, you can measure the dollar value of the customer accounts- based on:

• Differently priced plans
• Monthly subscriptions
• Multi-year contracts

The ACV sales calculations depend on the recurring revenue generated by an account or a client. It is less likely to have initial setup, administrative, or training fees.

How To Use ACV

ACV can normalize your contract amounts. You will be able to use it for:

• Comparing customers whose contracts differ in the type of duration
• Providing better service to the individual client- to those who have long-term potential
• Discovering which of the accounts provides the greatest source of revenue

Here’s an example of what ACV is in sales:

You have closed numerous subscription-based deals- that involve different periods and different prices. Now, you want to calculate the annual sales quickly. With ACV you can calculate the average revenue of all contracts that you initiate.

What Is ARR?

With annual recurring revenue, you can calculate the recurring income that your subscription accounts generate.

ARR calculations:

• Let you measure the recurring revenue at a set time
• Measure the complete value of the recurring revenue on an annual basis
• Eliminate one-time charges into account

How To Use ARR

As ARR predicts annual income from the subscription accounts- it is great for indicating financial health. You can use it for:

• Tracking your revenue growth over time
• Analyzing sales, retention, and marketing strategies- also improve upon those strategies
• Predicting revenue by pinpointing revenue fluctuations from subscription renewals, upsells, and cancellations.

In case your SaaS company offers monthly subscriptions- you would want to calculate “monthly recurring revenue” or MRR. You will get the ARR value by multiplying the MRR x 12.

ACV vs ARR: The Differences

Now we know that ACV and ARR both measure the annualized contract values- but there are fundamental differences. Businesses use ACV metrics to measure a single account over multiple years. Whereas, ARR measures multiple accounts at once:

For example, you have two customers.

• Customer X pays for a $500 annual subscription plan- therefore, their ACV is $500
• Customer Y pays for a $1,000 annual subscription plan- therefore, their ACV is $1,000

Meanwhile, the ARR is $500 + $1,000 = $1,500

The above example is a familiar one- the measurements can be used in various ways based on companies. Like, SaaS companies do not see ACV as a standard metric.

Here are the main differences between ACV and ARR to understand:

• ACV is used for measuring the income from a single, subscription-based account or contract. ARR measures the revenue of all the subscription-based accounts or contracts of a company.
• ACV formula can vary depending on the company. ARR has a standardized formula for most companies.
• ACV calculates annual contract value in average dollar amount which remains normal across a year. ARR calculates recurring total dollar amounts that are generated annually.
• ACV may include initial or one-time contract charges. ARR never includes initial or one-time contract charges.
• Comparatively, ACV is limited in scope when you apply it in isolation, but best to use it with other metrics.

ARR can track revenue growth and can be used for better business, sales, and marketing decisions.

Calculating ACV and ARR

Companies can interpret ACV and ARR a little differently. It’s okay as long as the calculations run in a standardised way and everyone is on the same page.

Calculating ACV

The standard formula of calculating ACV per account:
ACV= Total contract value divided by number of years
Suppose a customer has signed a five-year annual subscription contract where the total value of the contract is at $2500. The ACV calculation will be:
ACV= $2500/ 5 = $500
But what happens if another customer opts for a three-year, monthly subscription contract at $90 per month? Here’s how to use the ACV formula to normalize a customer’s contract over a year.
Annual subscription rate = $90 x 12 months = $1080
Total contract value = $1080 x 3 years = $3240
ACV = $3240 / 3 = $1080
Calculating ACV Across Multiple Contracts
There are creative ways- one can use ACV for making certain data easier to understand.
For example, you can get average ACV of multiple contracts with this simple formula:
Average ACV = Total ACV of contracts divided by number of contracts
You can use the formula in various ways.

Calculating ARR

Here’s a fast and easy method to calculate ARR- it’s a much more accurate and standard method. First, you need to subtract the non-recurring income source from the annual revenue of the previous year.

ARR = Complete annual revenue minus Non-recurring revenue

You will get a general view of what your ARR looks like. But this formula of ARR doesn’t consider if there’s any change in customer subscriptions.
SaaS companies may use the annual run rate for the first year- instead of using ARR. It’s better to use an annual run rate to get revenue forecasts- helps to get more data to work with.

Standard formula to calculate ARR:

ARR = Beginning of the year ARR + Gained ARR from new customers + Gained ARR from subscription upgrades – Lost ARR to subscription downgrades – Lost ARR to customer churning

Let’s assume you have 200 annual customer subscription contracts on 1st January- each of the contracts yields $1100 in recurring revenue.

In case, everything remains unchanged in the coming months and there is no non-recurring revenue- the ARR will be equal to the total annual revenue from last year or, 200 x $1100 = $220,000.

Now, let’s say over the year some changes unfold in your company:

• Gains 30 new $1100 customer subscriptions- (30 x $1100 = $33,000)
• 5 existing customers downgrade to $900 subscriptions; loss count – (5 x $200 = 1,000)
• 10 existing customers canceled their subscriptions; loss count- (10 x $1100 = 11,000)

Now to determine the ARR in real time, put the amount in the above-mentioned formula:

ARR = $220,000 + $33,000 – $1000 – $ 11,000 = $241,000 (If we assume there are no upsells in a year)

If the company offers monthly subscriptions, then you can calculate the MRR following the above-described formula. Then to retrieve the ARR value, just multiply the result by 12.

Tools For Analyzing The Metrics

You may feel overwhelmed by all the revenue metrics tools including ACV, and ARR- but don’t worry, there are analytical tools that make your job easier. With some analytical tools, you can see real-time sales data inside a CRM along with the overall view of your business performance.

When you can track the recurring revenue using a CRM tool- it gives you a solid ground to use the data for upselling, subscription costs tweaking, cross-selling, or measuring ACV sales.

Who Benefits From Using ACV and ARR? What For?

So, who is going to benefit from knowing the terms like ARR and ACV? Any B2B companies, startups, SaaS sales teams, SaaS marketing teams, and management professionals with subscription models can reap the benefits.

Sales Representatives
If you are a sales representative, ACV can help you to analyze your customer base and identify the accounts that may need your timely attention. Here’s how these metrics benefit you:

• Initiate retention strategies
• Get in touch with the customers with add-on products or services
• Negotiate with them for an extension of the contract

Also, you can track your annual sales income with ACV.

Sales/Marketing Managers
Are you a sales or marketing manager? You can utilize ACV and ARR along with a variety of sales dashboard templates for:

• Tweaking the training efforts
• Monitoring the team’s performance
• Taking profitable decisions and offering better recommendations to the department

C-Suite Professionals
If you oversee company finances, you can use year-after-year ARR comparisons for improving the projections and timing:

• Company valuation
• Hiring additional staff (if need be)
• Get forecasts of future revenues and annual budgets
• Large capital expenditures

When you are using ARR metrics, it helps you to witness new cash inflow and/or outflow.

Conclusion

Now, you have a better idea about how companies view and use ACV and ARR metrics for both team and personal performance. Here are a few benefits you can receive from measuring regular revenue:

• Customer success and how sales strategies are working
• Better product development and marketing strategies
• Investment decisions based on future planning

When you understand the results better, your team will thrive- leaving a positive impact on your business.