Annual Contract Value (abbreviated as ACV) is defined as the total sum of revenue that a customer contract generates in a year. In other words, ACV is the total value of the contract to indicate the actual annual revenue you will generate from a certain contract or agreement. ACV is commonly used as a revenue metric by Software as a Service (SaaS) companies that roll out periodic subscriptions to their customers.
Read the following examples to get a better understanding of ACV:
ACV is an important SaaS revenue metric because of the following reasons:
a. How much revenue is generated per year per customer contract?
b. How many contracts should the company have to cover the customer acquisition cost?
The insights from ACV can help the sales team to make better data-driven business decisions to boost the annual value.
ACV is not a standard metric like monthly recurring revenue (MRR) or annual recurring revenue (ARR). There are many possible methods to calculate the ACV. However, the most popular method i.e used by the majority of SaaS businesses makes use of total contract value in the calculation.
Annual Contract Value (ACV) = Total Contract Revenue / Total years in the contract
ACV calculation is conducted using the above formula for both long-term and short-term customers. Look at the examples below for a better understanding of the ACV formula.
a) Short-Term Customer
Suppose a company entered into a 3-month contract with a customer specifying a total revenue of $5,000 for the company.
To calculate the ACV in this case,
Hence, the ACV will be equal to $5,000. Even though the total duration of the contract is 3 months but the duration considered for the calculation of ACV is 1 year. This is because the term ‘annual’ in Annual Contract Value denotes the revenue you will earn per customer per year.
b) Long-Term Customer
Suppose a company entered into a 10-year contract with a customer specifying a total revenue of $100,000 for the company.
To calculate the ACV in this case,
Hence, the ACV will be equal to $10,000. It is important to note that even if the client has to pay a one-time fee as a registration or setup fee, it won’t impact the ACV because it only calculates the revenue generated as per the contract.
If you are calculating the average ACV for the whole company, you can add the ACVs for each customer and divide it by the number of customers. For instance, if a company entered into a 3-year contract with customer A specifying a total revenue of $30,000 and another 1-year contract with customer B with total revenue of $2,000.
People often get confused between these metrics because the definitions of both these metrics are somewhat similar, and the values can be the same in many cases. Similar to Annual Contract Value (ACV), Annual Recurring Revenue (ARR) is also one of the SaaS metrics used by businesses that have a subscription-based business model. However, ARR is more commonly used as a revenue metric to benchmark a company’s growth as compared to ACV.
Annual Contract Value (ACV) helps in the measurement of the average sum of revenue that a company can earn from business contracts in a year. Whereas, Annual Recurring Revenue (ARR) helps in the measurement of the total amount of revenue that a company can earn from their customers on a recurring basis. This is the primary reason that causes the ACV and ARR values to differ in most cases.
For instance: If a SaaS company has only monthly paying customers, the ARR will be significantly higher than the ACV. On the other hand, if the company has many customers who pay one or two years in advance, the ACV will probably be higher than the ARR. Therefore, it is important to choose the key performance metrics of a company depending on the majority of its customers.