Every corporate SaaS company, as well as those whose business model is mainly based on yearly contracts and subscriptions, is familiar with the words “annual contract value” (ACV) and “annual recurring revenue” (ARR). Let us understand the difference between ARR vs. ACV sales.
So, what does it truly imply for a sales or marketing professional or a company’s finance team? With Gartner forecasting worldwide SaaS revenue of $140.6 billion in 2022 and considering the many KPIs SaaS organizations track and measure to analyze their growth, it’s critical to comprehend ACV and ARR as concepts.
In this section, we discuss the ARR vs. ACV sales and metrics in detail and why they are important. It’s also vital to understand how ACV differs from ARR and how SaaS marketers employ the two.
ARR vs. ACV Sales – Definition, Differences, and Benefits
What is ACV?
ACV (annual contract value) is a critical measure that demonstrates the value of an ongoing customer contract by averaging and normalizing its value over a year. You can use ACV to calculate the monetary value of all your client accounts, regardless of whether they involve:
- Subscriptions are charged monthly
- Plans with varying prices
- Contracts for multiple years
ACV sales calculations are primarily based on recurring revenue earned by a single client or account. They do not include one-time or initial setup, training, or administrative expenditures.
Because ACV normalizes contract amounts, you can use it to:
- Contrast customers whose contracts differ in terms of type or duration
- Determine which accounts have the highest revenue value
- Improved service to individual clients, particularly those with the most long-term potential
Here’s a basic use-case example to help clarify what ACV is in sales.
Assume you’ve recently closed many subscription-based deals involving varied periods and price amounts. You’d need a rapid estimate of your annual sales. ACV can assist you in determining the average, normalized revenue worth of each contract you establish.
What is APR?
ARR (annual recurring revenue) is a measure that displays the total amount of recurring money generated by all of your subscription accounts. Calculating ARR:
- On an annual basis, calculate the entire monetary worth of your recurring revenue
- Do not include one-time fees or costs
- Allows you to calculate your revenue at a specific point in time
ARR is a good predictor of financial health because it gauges predictable annual revenue. You can also use it to:
Monitor revenue increase over time
Estimate revenue by identifying income swings caused by subscription renewals, upsells, or cancellations
Examine and enhance your sales, marketing, and retention methods
If your SaaS company sells monthly subscriptions, you should additionally track MRR (monthly recurring revenue). ARR is calculated by multiplying MRR by 12.
ARR vs. ACV Sales
The major distinction between ARR and ACV sales metrics is where your measurements are focused. When calculating yearly contract value, you look at only one account to estimate how much average recurring revenue is generated from that particular source.
Meanwhile, yearly recurring income is the total cash earned from each recurrent contract over a year. MRR, or monthly recurring revenue, divides the time frame into months rather than a single year.
There are significant distinctions in the types of contracts that can be measured. ARR is only useful when calculated with contracts that last a year or more. If a client commits to an eight-month plan, you wouldn’t want to apply that money to your annual calculation because it would result in an incorrect tally.
Because of these constraints, annual recurring revenue is less effective as a measure of individual achievement. However, because ARR is a more precise technique for assessing yearly income, it’s an excellent approach to tracking revenue growth.
When Should You Use ARR vs. ACV Sales
When calculating ACV and ARR, you get different numbers; therefore, when should you use each metric? ACV isn’t particularly relevant, but combining it with other SaaS metrics can provide useful insights. ARR is something that you can and should track on its own. I’ll go over the details.
Use APR for year-over-year growth
Tracking ARR gives you a high-level snapshot of your company’s health and allows you to calculate the rate at which you need to expand to build on your success. Recurring revenue, particularly as a subscription business, underlies your pricing strategy and business model. Understanding your ARR reveals your momentum and compound growth.
Monthly recurring revenue, or MRR, is another term for ARR. I’ll break down MRR separately in a moment. Keeping track of both MRR and ARR allows you to plan for the short and long future. Companies with more than $10 million in ARR focus on recurring yearly revenue rather than monthly revenue.
Use ACV for customer success performance and sales team
While ARR monitors year-over-year increases, ACV is utilized to track the performance of your sales and customer success teams over time. Calculating ACV assists in informing your strategy and determining how much you should invest in sales and marketing initiatives.
Subscription businesses with a high or low ACV can be profitable; nonetheless, it is critical to understand your company’s goals. Lower-end ACVs are OK; they indicate that you will require more consumers.
There are numerous ways to spin different SaaS indicators. Still, the main issue is that all business units are on the same page regarding calculations and calculating figures. The precise worth of metrics is usually determined by the level of granularity and how you package your subscriptions.
Now that you understand what a company’s ARR and ACV mean, you’ll be able to find numerous methods to leverage these two critical indicators to boost personal and team performance.
Whatever position you play as a SaaS professional, the better you understand the results you and your team produce, the more control you have over their impact.