What Is Annual Contract Value (ACV)? Calculation and Examples

Signing on the dotted line screams large dedication for a purchaser and excellent news for a vendor.

The quantity of offers a enterprise can efficiently shut is clearly a key worth to measure for B2B firms. It signifies that your gross sales group effectively reels in beneficial prospects, earns their belief, and will get them to purchase your answer.

However what in regards to the typical worth behind these closed-won offers? When a contract is signed, how do you assess the monetary influence on your online business? That is the place annual contract worth (ACV) comes into play, serving to you perceive what to anticipate from every contract. 

Use a sales performance management tool to watch your gross sales progress and course right.

What is annual contract worth?

Annual contract worth (ACV) is the typical annual income generated from every buyer contract, excluding any one-time charges. It is primarily utilized by software-as-a-service (SaaS) firms that provide options via annual or multi-year subscription plans.

Measuring ACV by itself doesn’t provide that a lot worth to companies. It’s mostly in contrast towards different gross sales metrics which are associated to bills, like buyer acquisition value (CAC). For those who examine ACV and CAC, you may see what number of contracts should be signed to generate sufficient income to cowl the price of buying prospects.

Learn how to calculate ACV

Annual contract worth contains the worth of all income from subscriptions normalized throughout one yr. To calculate your ACV, take the entire worth of your entire contracts and divide that quantity by the entire variety of years within the contract. The ACV system is as follows:

Extra ACV components

Sadly for these searching for excellent consistency in each gross sales metric, ACV doesn’t present that. Every enterprise may need their very own particular person methodology of calculating ACV.

Some would possibly use the essential equation given above, however others would possibly take the next values under consideration:

• One-time charges: Issues like coaching, onboarding, and implementation charges additionally generate income for a enterprise, so some would possibly embrace it of their ACV calculation. Since these charges are solely paid as soon as within the first yr of the contract, the ACV for companies that take these charges under consideration will likely be greater in 12 months 1 than in 12 months 2, 3, and so on.
• Enlargement: Buying new prospects may end up in the revenue you achieve from them growing over time via up-selling and cross-selling techniques.
• Churn: The loss of existing customers devalues your investment of acquiring them.

Calculating annual contract value: examples

With that formula in mind, let’s look at an example of how to calculate ACV with both a short-term and long-term customer.

Your long-term customer, Fake Company 500, has signed a 5-year contract with your business worth $125,000. Fake Company 500 will pay an annual fee for your solution. The ACV for Fake Company 500 would be $25,000 per year.

$125,000 / 5 years = $25,000 per year 

Say you have another customer, Real Company ABC, that’s more interested in a short term commitment. They signed a 6-month contract worth $4,000 and will be making payments monthly. Since ACV is averaged over the year, as opposed to the length of the contract, the ACV for Real Company ABC is $4,000 per year.

$4,000 / 6 months = $4,000 per year

The best way to find your ACV across all current customer accounts is to do so while comparing it to annual recurring revenue, which will be discussed next.

Why is ACV important?

Because it’s simply an additional method for representing revenue in some way or another, average contract value isn’t that great of an insight standing alone. Businesses measure ACV to see how they’re performing in other key areas – a popular one being CAC.

CAC is the cost associated with convincing someone to purchase your solution. Comparing revenue-adjacent values against CAC is an effective way to measure the profitability of a business. For example, businesses will compare CAC to customer lifetime value (CLV) and determine if the value of a long-term relationship with a customer is enough to account for the cost of acquiring them.

The comparison of ACV and CAC asks the question: “How many deals do I need to close to cover my customer acquisition cost?”

Because ACV is averaged across all current subscriptions, it offers insight into how many deals a business needs to close to make a certain amount of money. Businesses will look at CAC and determine how many deals they need to close to cover it (based on ACV).

For the reason stated above, ACV is also used when setting revenue goals. Businesses will take annual contract value and conversion rate into account when forecasting revenue for a certain time period.

For example, if your ACV is $10,000 and your sales team hovers around 4 deals a quarter, you can project that your business will generate an estimated $40,000 in revenue that quarter.

Tip: Acquiring new customers is tough, and you don’t want to waste money trying to reel in people who aren’t even interested. G2’s Buyer Intent Data can present you the businesses researching your online business, so you may attain out to the fitting individual on the proper time.

Annual contract worth and different SaaS metrics

Along with ACV, there are different key subscription metrics in the SaaS space that help businesses understand their revenue streams and growth potential. Let’s dive into annual recurring revenue (ARR) and total contract value (TCV), and see how they complement ACV to give a full financial picture.

ACV vs ARR

Annual contract value and annual recurring revenue are seen as cousins in the sales world. Because the definitions are so similar and the values can sometimes mirror each other, annual contract value and annual recurring revenue are often confused for one another. Let’s set the record straight.

ACV is the average amount of money being generated from subscription-based activities for that year. ARR is the value of recurring revenue of a business’ subscriptions for a single calendar year. Essentially, it’s the yearly income from one subscription.

When only one customer’s ARR and ACV are being measured, they’re often the same value – the amount of money that a business will make from that customer for the year. Things get a bit more confusing when looking at total ACV vs ARR.

ACV vs ARR example

The best way to show an example of ACV and ARR is to work with multiple customers and measure values over multiple years.

Let’s break it down by customer and then show the combined total ACV and ARR for this business, using Fake Company 500 again.

Customer A agrees to a $2,000 contract for one year. They will pay Fake Company 500 annually. Since the value of the contract is $2,000 and the number of years in the contract is one, ACV is $2,000. Because Fake Company 500 will be receiving $2,000 in revenue for the year from that customer, ARR is $2,000.

ACV: $2,000
ARR: $2,000

Customer B agrees to a $1,600 contract for two years. They will pay Fake Company 500 annually. Since the total value of the contract is $1,600 and the total number of years in the contract is two, ACV is $800. Because Fake Company 500 will be receiving $1,600 in revenue across two years, ARR is also $800.

ACV: $800
ARR: $800

Customer C agrees to a $1,200 contract for three years. They pay Fake Company 500 annually. Since the total value of the contract is $1,200 and the total number of years in the contract is three, ACV is $400. Because Fake Company 500 will be receiving $1,200 in revenue across three years, ARR is also $400.

ACV: $400
ARR: $400

Now, that might not look like much and you might be a bit confused. Bear with me! Once we do a final calculation for the year that takes all three customers into account, the difference between ACV and ARR will make a lot more sense.

ARR example

Let’s start with ARR. To calculate ARR, simply add the value from each contract that Fake Company 500 will be receiving that year.

In Year 1, Fake Company 500 will receive $2,000 from Customer A, $800 from Customer B, and $400 from Customer C, resulting in $3,200 in annual recurring revenue.

$2000 + $800 + $400 = $3,200

At the end of Year 1, Customer A’s contract has ended, so they’ll no longer be paying a subscription. In Year 2, Fake Company 500 can expect another $800 from Customer B and $400 from Customer C. Their ARR for Year 2 would be $1,200.

$800 + $400 = $1,200

In Year 3, Customer C is the only one remaining with a contract. Since they pay $400 a year, the ARR for Fake Company 500 would be $400 for Year 3.

ACV example

Now let’s take a look at ACV.

In Year 1, Fake Company 500 will generate $2,000 in revenue from Customer A, $800 from Customer B, and $400 from Customer C. There are three contracts in question, so Fake Company 500’s ACV for Year 1 is $1,067.

$2,000 + $800 + $400 = $3,200 / 3 = $1,067 per year

In Year 2, just like with ARR, Fake Company 500 will only be generating revenue from Customer B, who will pay $800, and Customer C, who will pay $400. The ACV for Year 2 would be $600.

$800 + $500 = $1,200 / 2 = $600 per year

In Year 3, Fake Company 500’s only customer is Customer C. Since they pay $400 a year, the ACV for Year 3 would be $400.

$400 / 1 = $400 per year 

Total contract value (TCV)

When speaking on ACV, it’s important to touch on total contract value as well.

TCV refers to the total value of a contract, including fees and recurring revenue. ACV is a good value to measure when determining which customer is offering the most consistent income, but TCV tells you which contract is the most valuable overall.

To calculate TCV, simply add the total recurring revenues from the contract to the additional contract fees. For example, if you close a deal with a $100 onboarding fee and a $20 a month subscription for 12 months, your TCV will be $340.

$100 + ($20*12) = $340

ACV for SaaS businesses

Annual contract value is a highly valued metric for SaaS businesses. Because their main source of revenue is licensing software using contracts, the everyday worth related when closing a deal will have an effect on the remainder of the enterprise.

SaaS companies like to know the benchmark worth of any metric for his or her trade and ask questions like, “What is a good ACV for my business?” And naturally, the reply is that it relies upon. Companies will be profitable with each excessive and low ACVs.

As a result of the important thing goal of ACV is to behave as a price to check different metrics towards, the reply relies on the worth of that second metric. As talked about above, the most typical metric to check ACV with is buyer acquisition value. If your online business has a low CAC, then an ACV on the decrease finish is alright. So long as your ACV can outweigh your CAC, you’re in fine condition.

Take into consideration a enterprise like Adobe, whose merchandise will be bought to particular person shoppers. When promoting to this viewers, the ACV goes to be low as a result of one license is being bought to 1 shopper, however since the price of buying new prospects can be low, the enterprise can nonetheless be worthwhile.

However, there are companies like HubSpot that promote to complete firms. Since HubSpot’s options are dearer and contain an extended gross sales cycle, their CAC goes to be fairly excessive. Nonetheless, their ACV can be fairly excessive, to allow them to nonetheless see a revenue.

It’s necessary to remain centered on your online business and your online business alone when occupied with what a “good” ACV is.

Learn how to enhance SaaS ACV

Now that you understand how to measure your annual contract worth and perceive which metrics to check it towards, you would possibly’ve realized that your ACV might use somewhat assist.

As a result of ACV relies upon so closely in your particular answer and marketing strategy, it’s exhausting to spherical up a gaggle of things that may be modified to constantly end in the next ACV. One thing that works for one enterprise will be fully mistaken for an additional.

Nonetheless, there are two issues you are able to do to spice up your ACV that may appear apparent, however are price noting.

1. Deal with up-selling

As your prospects and their companies develop, so will their software program wants. Discovering opportunities to up-sell, which is a gross sales method the place a rep makes an attempt to persuade the shopper to purchase a dearer answer, is an effective way to extend the worth of your common contract. Extra money equals extra worth.

Nonetheless, it’s good to watch out when up-selling to your prospects. Sure, it’s your job as a gross sales rep to shut offers for your online business and generate as a lot income as attainable, however you might be additionally there to serve the shopper. In the event that they really feel pressured to make a buying choice they aren’t prepared for, you possibly can lose their enterprise altogether.

Achieve a deep understanding of their enterprise, look ahead to development, and current the chance when it makes probably the most sense for them, not you.

Tip: One of the simplest ways to up-sell is to know your prospects and anticipate their wants. CRM software may help you construct that vital relationship, so when the time comes for them to improve to a brand new answer, you’ll be prepared.

2. Increase your costs

This one can’t be elaborated on an excessive amount of – elevating your costs will enhance your ACV. Once more, more cash equals extra worth.

Whereas the thought is easy, the method of doing so isn’t. When elevating costs, there are some issues that can make your prospects indignant and stingy with their wallets. Not giving them sufficient discover or tricking them into signing a contract with out mentioning the value change may end up in these prospects strolling away and not using a second thought.

You would possibly be capable of get away with elevating your costs, however by no means ever accomplish that maliciously. Deal with your prospects the way in which you prefer to be handled as a purchaser.

Don’t sleep on annual contract worth

Annual contract worth is an usually neglected and underestimated gross sales metric. Whereas it doesn’t imply a lot standing alone, evaluating ACV towards different values offers beneficial insights when making enterprise selections.

Keep knowledgeable by getting a very good grip on what ACV is smart for your online business and by no means lose sight of it – otherwise you would possibly endure the implications.

ACV can be utilized to tell loads of different elements of your promoting technique, together with quotas. Discover ways to set gross sales quotas that align together with your ACV, profit the enterprise, and encourage your reps.

This text was initially printed in 2020. It has been up to date with new data.