{"id":223974,"date":"2020-03-14T08:55:11","date_gmt":"2020-03-14T03:25:11","guid":{"rendered":"https:\/\/www.qcsglobal.com\/marketing\/annual-contract-value-acv-a-big-deal-for-your-bottom-line\/"},"modified":"2020-04-18T17:10:37","modified_gmt":"2020-04-18T11:40:37","slug":"annual-contract-value-acv-a-big-deal-for-your-bottom-line","status":"publish","type":"post","link":"https:\/\/qcsglobal.com\/blogs\/annual-contract-value-acv-a-big-deal-for-your-bottom-line\/","title":{"rendered":"Annual Contract Value (ACV): A Big Deal for Your Bottom Line"},"content":{"rendered":"


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Signing on the dotted line screams big commitment for a buyer and good news for a seller.<\/p>\n

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The amount of deals a business can successfully close is obviously a key value to measure<\/a> for B2B companies. It indicates that your sales team efficiently reels in valuable customers, earns their trust, and gets them to buy your solution.<\/p>\n

But what about the typical value behind those closed won deals? When a contract is signed, what can your business expect to gain from it financially?<\/p>\n

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What is annual contract value?<\/h2>\n

Annual contract value (ACV) refers to the average annualized revenue per customer contract. ACV is most commonly used by SaaS businesses that sell solutions with an annual or multi-year subscription plan.<\/p>\n<\/div>\n

Essentially, ACV is the average amount of revenue generated from a single customer contract for that year.<\/p>\n

Measuring ACV by itself doesn\u2019t offer that much value to businesses. It\u2019s most commonly compared against other sales metrics<\/a> that are related to expenses, like customer acquisition cost (CAC). If you compare ACV and CAC, you can see how many contracts need to be signed to generate enough revenue to cover the cost of acquiring that customer.<\/p>\n

Looking for a specific aspect of annual contract value? Use the links below to skip to wherever you\u2019d like:<\/p>\n

<\/a><\/p>\n

Example of ACV<\/a>
ACV vs ARR<\/a>
Why is ACV important?<\/a>
Total contract value<\/a>
Additional ACV factors<\/a>
ACV SaaS<\/a>
How to increase ACV<\/a><\/p>\n

Annual contract value formula<\/h2>\n

Annual contract value includes the value of all revenue from subscriptions normalized across one year. To calculate your ACV, take the total value of all of your contracts and divide that number by the total number of years in the contract.<\/p>\n

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\"acv<\/p>\n

Example of ACV<\/h2>\n

With that formula in mind, let\u2019s look at an example of how to calculate ACV with both a short term and long term customer.<\/p>\n

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.<\/p>\n

$125,000 \/ 5 years = $25,000 per year\u00a0<\/p>\n

Say you have another customer, Real Company ABC, that\u2019s 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.<\/p>\n

$4,000 \/ 6 months = $4,000 per year<\/p>\n

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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.<\/p>\n

ACV vs ARR<\/h2>\n

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 (ARR) are often confused for one another. Let\u2019s set the record straight.<\/p>\n

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\u2019 subscriptions for a single calendar year. Essentially, it\u2019s the yearly income from one subscription.<\/p>\n

When only one customer\u2019s ARR and ACV are being measured, they\u2019re 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 and ARR.<\/p>\n

ACV vs ARR example<\/h4>\n

The best way to show an example of ACV and ARR is to work with multiple customers and measure values over multiple years.<\/p>\n

Let\u2019s break it down by customer and then show the combined total ACV and ARR for this business, using Fake Company 500 again.<\/p>\n

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.<\/p>\n

ACV: $2,000
ARR: $2,000<\/p>\n

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.<\/p>\n

ACV: $800
ARR: $800<\/p>\n

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.<\/p>\n

ACV: $400
ARR: $400<\/p>\n

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.<\/p>\n

ARR example<\/h4>\n

Let\u2019s start with ARR. To calculate ARR, simply add the value from each contract that Fake Company 500 will be receiving that year.<\/p>\n

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.<\/p>\n

$2000 + $800 + $400 = $3,200<\/p>\n

At the end of Year 1, Customer A\u2019s contract has ended, so they\u2019ll 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.<\/p>\n

$800 + $400 = $1,200<\/p>\n

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.<\/p>\n

ACV example<\/h4>\n

Now let\u2019s take a look at ACV.<\/p>\n

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\u2019s ACV for Year 1 is $1,067.<\/p>\n

$2,000 + $800 + $400 = $3,200 \/ 3 = $1,067 per year<\/p>\n

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.<\/p>\n

$800 + $500 = $1,200 \/ 2 = $600 per year<\/p>\n

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In Year 3, Fake Company 500\u2019s only customer is Customer C. Since they pay $400 a year, the ACV for Year 3 would be $400.<\/p>\n

$400 \/ 1 = $400 per year\u00a0<\/p>\n

Why is ACV important?<\/h2>\n

Because it\u2019s simply an additional method for representing revenue in some way or another, average contract value isn\u2019t that great of an insight standing alone. Businesses measure ACV to see how they\u2019re performing in other key areas – a popular one being customer acquisition cost (CAC).<\/p>\n

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 and determine if the value of a long-term relationship with a customer is enough to account for the cost of acquiring them.<\/p>\n

The comparison of ACV and CAC asks the question: \u201cHow many deals do I need to close to cover my customer acquisition cost?\u201d<\/p>\n

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).<\/p>\n

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<\/a> revenue for a certain time period.<\/p>\n

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.<\/p>\n

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TIP:<\/strong> Acquiring new customers is tough, and you don\u2019t want to waste money trying to reel in people who aren\u2019t even interested. G2\u2019s Buyer Intent Data<\/a> can show you the companies researching your business, so you can reach out to the right person at the right time.<\/p>\n

Total contract value (TCV)<\/h2>\n

When speaking on ACV, it\u2019s important to touch on total contract value as well.<\/p>\n

Total contract value (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.<\/p>\n

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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.<\/p>\n

$100 + ($20*12) = $340<\/p>\n

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Additional ACV factors<\/h2>\n

Unfortunately for those looking for perfect consistency in every sales metric, ACV doesn\u2019t provide that. Each business might have their own individual method of calculating ACV.<\/p>\n

Some might use the basic equation given above, but others might take the following values into account:<\/p>\n

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