Businesses often discuss ACV Vs ARR as key revenue metrics, but it’s crucial to understand they are not interchangeable.
These terms are frequently mentioned in boardrooms and executive meetings, yet many companies struggle to leverage them effectively.
SaaS business success relies on subscription models, revenue growth, average revenue, and recurring income. Strong ARR and ACV figures support growth and provide key performance indicators (KPIs), but they serve different purposes.
This article explores the difference between ACV Vs ARR and where each metric is most beneficial and how to apply them effectively.
Definition of ACV Vs ARR
ACV: Annual Contract Value (ACV) is a metric that businesses use to calculate the total yearly income generated from a customer’s contract. It’s commonly used in SaaS and telecom sectors where clients sign contracts for specific periods.
ARR: Annual Recurring Revenue (ARR) measures the predictable, recurring revenue a business expects to generate over a year.
Steps to calculate ACV
ACV formula = ACV= Total contract value / Number of years
Example 1
Customer X signs a two-year annual subscription contract with a total value of $2000.
ACV= 2000/2=1000
Example 2
Customer Y signs a four-year contract worth $8000.
ACV= 8000/4=2000
Example 3
Customer Z opts for a three-year, monthly subscription contract at $150 per month.
- Annual subscription rate
150×12=1800
- Total contract value:
1800×3=5400
- ACV
5400/3=1800
ACV helps businesses compare various types of recurring revenue accounts quickly.
Calculating ACV Across Multiple Contracts:
Calculate the ACV for each account and then average them.
- Customer A: $3000 ACV
- Customer B: $4500 ACV
- Customer C: $6000 ACV
Total ACV
3000+4500+6000=13500
Average ACV
13500/3=4500
Method 2
Batch calculations for multiple customers.
Three customers on one-year contracts worth $20,000 each.
20000×3=60000
Four customers on two-year contracts worth $50,000 each.
500002×4=100000
Two customers on three-year contracts worth $90,000 each.
900003×2=60000
Total ACV
60000+100000+60000=220000
Average ACV
220000/9≈24444
Steps to calculate ARR
Example
If your total annual revenue is $500,000 and non-recurring revenue is $50,000,
ARR=500000−50000=450000
Standard Calculation Method
Formula
ARR=ARR at beginning of the year+ARR from new customers+ARR from upgrades−ARR lost to downgrades−ARR lost to churn
Example:
Starting ARR: 150 annual subscriptions at $1000 each.
150×1000=150000
During the year:
Gain 30 new $1000 subscriptions.
30×1000=30000
Upsell 15 customers to $1500 subscriptions.
15×500=7500
Downgrade 20 customers to $800 subscriptions
20×200=4000
Lose 5 customers ($1000 each).
5×1000=5000
ARR Calculation:
ARR=150000+30000+7500−4000−5000=178500
For monthly subscriptions, calculate MRR first, then annualize it:
MRR=∑(Monthly revenue)
ARR=MRR×12
By understanding and calculating these metrics accurately, businesses can better monitor financial health, plan growth strategies, and optimize revenue streams.
If you want to read more about ARR, we have discussed this topic in details in a separate article.
Check out: What is Annual Recurring Revenue (ARR) ?
Examples ACV Vs ARR
Example: Calculating ACV for a SaaS Company
Company: CloudSoft Solutions
Service: Cloud-based project management software
Customer Contract Details:
- Customer: TechCorp Inc.
- Contract Duration: 1 year
- Subscription Fee: $10,000 per year
- Additional Features Add-On: $2,000 per year
- Annual Support Fee: $1,000 per year
Calculation
- Base Subscription Fee: $10,000
- Add-Ons: $2,000
- Support Fee: $1,000
Annual Contract Value (ACV) = Base Subscription Fee + Add-Ons + Support Fee
ACV = $10,000 + $2,000 + $1,000
ACV = $13,000
Explanation
For TechCorp Inc., the total annual revenue generated from their contract with CloudSoft Solutions is $13,000. This includes the base subscription fee of $10,000, an additional $2,000 for extra features, and a $1,000 annual support fee.
This ACV helps CloudSoft Solutions understand the yearly value of their contract with TechCorp Inc., providing insight into revenue from this specific customer. Additionally, it aids in planning for pricing strategies and evaluating the overall value of customer contracts.
Example: Calculating ARR for a Subscription-based Company
Company: FitnessPro Solutions
Service: Online fitness training and wellness programs
Customer Subscription Details:
- Monthly Subscription Fee per Customer: $50
- Number of Subscribers: 500
- Annual Subscription Fee per Customer: $600 ($50 x 12 months)
- Additional Services (e.g., personalized coaching): $10,000 per year
Calculation
- Monthly Subscription Revenue:
- Monthly Fee x Number of Subscribers = $50 x 500 = $25,000
- Annual Subscription Revenue from Monthly Fees:
- Monthly Subscription Revenue x 12 months = $25,000 x 12 = $300,000
- Additional Annual Revenue (Personalized Coaching):
- $10,000
Annual Recurring Revenue (ARR) = Annual Subscription Revenue + Additional Annual Revenue
ARR = $300,000 + $10,000
ARR = $310,000
Explanation
FitnessPro Solutions generates $25,000 per month from 500 subscribers, which amounts to $300,000 annually from monthly subscriptions.
Additionally, they earn $10,000 per year from personalized coaching services. Therefore, the total Annual Recurring Revenue (ARR) for FitnessPro Solutions is $310,000.
This ARR figure helps FitnessPro Solutions assess their predictable, recurring revenue for the year, providing valuable insight into the company’s financial health and aiding in long-term planning and growth strategies.
Benefits and limitations of ACV Vs ARR
Who will use ACV Vs ARR
Financial services
Financial institutions like banks and wealth management firms leverage ARR to assess recurring revenue from services like deposit accounts and debit cards. ACV, meanwhile, measures one-time purchase revenue from offerings such as fha mortgage loans and credit cards.
Telecom companies
Telecom entities utilize ACV to quantify revenue from purchases like new phone plans and add-ons, while ARR tracks recurring revenue from subscription services such as data plans and roaming charges.
Software companies
Software firms primarily utilize the ARR metric to gauge recurring revenue from subscription-based services, aiding in identifying growth prospects and tracking progress towards objectives. Additionally, they employ ACV to assess revenue from one-time purchases, informing financial management and product pricing decisions.
Retail companies
In retail, both ARR and ACV are instrumental in evaluating the effectiveness of promotions, discounts, and new products. ARR tracks recurring revenue from subscriptions or loyalty programs, while ACV measures one-time purchase revenue.
Final thoughts
In summary, both ACV Vs ARR offer valuable insights into revenue generation and financial performance for businesses.
ACV provides a detailed view of revenue from individual contracts, aiding in pricing strategies and evaluating sales efforts.
However, it may be time-consuming to calculate and overlooks one-time transactions.
ARR, on the other hand, offers a broader perspective on recurring revenue trends, facilitating long-term financial planning and growth strategies.
By leveraging both metrics, businesses can gain a comprehensive understanding of their revenue streams and make informed decisions to drive success.
FAQs
Are there specific timeframes for ACV and ARR?
No, ACV and ARR do not adhere to fixed timeframes. Instead, companies determine the timeframe based on their specific business requirements. However, it’s recommended to maintain consistency in the timeframe chosen to ensure accurate benchmarking.
For example, if a company opts for a one-year timeframe for the initial three years’ calculations, it’s crucial to maintain the same timeframe for the fourth year and beyond. This consistency facilitates precise analysis and comparison of results.
What factors influence ACV and ARR?
Pricing stands as the primary factor influencing both ACV and ARR, given its direct impact on the company’s revenue generation potential. Additionally, customer behavior, marketing initiatives, and organizational objectives play significant roles in shaping both metrics. Evaluating ACV and ARR necessitates considering these factors diligently, given their substantial influence on the metrics’ outcomes.
How can you increase ARR and ACV?
Boosting ARR and ACV presents a pathway for businesses to amplify revenue and accelerate growth. Achieving this entails prioritizing pricing strategies, enhancing customer experience, refining product marketing, and bolstering customer retention efforts. By aligning these actions with ARR and ACV metrics, businesses can propel revenue generation, rendering them indispensable tools for burgeoning enterprises.
Which department should calculate ARR and ACV?
Typically overseen by the finance department, the calculation of ARR and ACV falls within its purview due to their financial nature. Nevertheless, other departments like marketing and sales may also contribute to this process. Their involvement can offer valuable insights into customer behavior, data analytics, advertising effectiveness, and other elements influencing these metrics.
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