Last editedSept 20202 min read
There are lots of different metrics that SaaS companies need to get to grips with, from monthly recurring revenue (MRR) to return on investment (ROI). One of the metrics that isn’t so well known is annual contract value (ACV), despite the fact that it can be an extremely effective way to understand the financial health of your SaaS business. Explore the importance of annual contract value in more detail, right here.
Annual contract value explained
Annual contract value is the annualised value of all your subscription revenue from each contracted customer. For example, if you have 50 customers who’ve signed a monthly subscription plan for $200 per month, your ACV would be $120,000 ($200 x 12 x 50). In most cases, one-time fees are not included in your annual contract value calculation. When looked at in isolation, annual contract value isn’t an especially useful metric. However, when paired with metrics like customer acquisition cost (CAC) it can be an effective means of understanding your company’s finances.
It’s important to understand that SaaS companies can be successful with low or high ACVs. Businesses focused on acquiring more consumers might have a lower annual contract value, but their lower customer acquisition cost means that they’ll have more users. On the other hand, B2B companies may have much higher ACVs, but they won’t have as many users as their clients cost significantly more to acquire. In other words, a small annual contract value isn’t necessarily bad, but it does mean that you’ll need to bring in more users.
How to calculate annual contract value
There isn’t a universally agreed-upon formula for doing an annual contract value calculation. This is because some companies include initial charges like training/onboarding in their calculation, while others don’t. Broadly speaking, we can calculate annual contract value using the following formula:
Annual contract value vs. revenue
One of the most common areas of confusion around ACV is the distinction between ACV and ARR (annual recurring revenue). Essentially, while ARR measures the value of your recurring revenue at a single point in time, annual contract value normalises that contract revenue over the course of one or more years. Using both an annual contract value calculation and an ARR calculation can give you the best visibility into your business’s finances and your ongoing financial health.
Why is annual contract value important for SaaS companies?
Having a solid understanding of annual contract value can provide you with the data-led insights you need to improve your strategic decision-making process. Firstly, it’s important to understand your company’s acquisition strategy. Are you trying to acquire lots of customers relatively cheaply, or are you going for a small number of big clients? Once you know what sort of annual contract value is required for your acquisition strategy, you can make better decisions regarding marketing and sales.
ACV or TCV: which metric should I use?
While annual contract value annualises revenue from each contract, TCV (total contract value) measures revenue from across the entire contract. Both metrics are important, but they’re used for slightly different things. If you need to know which of your customers are consistently paying you the most, you should do an annual contract calculation. However, if you’re more interested in exploring your most valuable customers across the entire contract term, TCV is the way to go.
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