Annual Contract Value (ACV)
What is annual contract value (ACV), and how to calculate it?
Annual contract value (ACV) is a sales metric for the SaaS industry, also known as “ACV bookings,” that typically represents the average annual contract value of a customer subscription.
If your business model relies on SaaS subscriptions, ACV in sales will be a metric that you will regularly think about as your company grows. Unlike Average Sales Price (ASP), which can be used to track certain events in a given time period, ACV in sales is used by SaaS businesses that have a primary focus on annual or multi-year subscription plans.
How to calculate ACV in sales
Every business will generally have their own internal methods to calculate ACV, which can create confusion across the SaaS industry. Each individual businesses may (or may not) consider one-time fees (training or implementation costs), revenue from upsells or cross-sells, customer (logo) churn rate, ACV for all contracts (combined together), or finding the average value of ACV for all contracts.
ACV in sales example formula
Taking a page from Lighter Capital’s example SaaS ACV calculation, below we will analyze the formula for ACV and its relation to other SaaS metrics.
Imagine your lead salesperson signs up a new customer for a 36-month contract for a total of $180,000. This will give you a Monthly Recurring Revenue (MRR) of $5,000. ACV is an annualized measurement spanning a 12-month period, so you’ll need to multiply your MRR by 12. This annual contract value comes to $60,000 in terms of its ACV in sales.
Expanding on this example, you might decide that you prefer to include the initial implementation and training costs as part of your calculations.
Let’s assume there’s a training fee of $8,000, plus a set-up fee of $2,500, as part of the total contract. This would change the ACV for the first year to $70,500 to incorporate the on-time fees, but the remaining two years will still have the original ACV of $60,000.
While the numbers you reach might appear exactly the same as calculations for Annual Recurring Revenue (ARR), individual SaaS companies can each use their own calculation methods.
Annual contract value vs ARR: what’s the difference?
Ostensibly, ACV and ARR can appear the same—as in both are representing the total annual value of all completed contracts. You will most likely arrive at the same number as your ARR if you add the values of your ACVs rather than averaging them, albeit in a less direct manner.
However, unlike ACV, ARR is a metric that reveals the amount of revenue a SaaS company expects to reoccur year-over-year and helps to visualize trends, measure growth, and forecast future revenue.
High vs low ACV: evaluating revenue and growth
A typical SaaS ACV should not necessary be evaluated on its own as just good or bad, but rather within the context of all other financial metrics measuring the success of the company. It’s best looked at in conjunction with other metrics such as ARR, customer acquisition cost (CAC), and Total Contract Value (TCV). For example, a higher ACV generally corresponds to a higher CAC, as more effort might be put into finding leads and converting them into larger, high value contracts.
Do your annual contract value calculations reveal low values when compared against other companies? If so, this might be because your sales process has lower friction. However, in truth, you might also be better off than your competitors as you may not be spending as much money and time on securing new customer contracts.
That said, any correlation between high vs. low ACV value and company growth is murky at best, particularly when ACV is used as a standalone metric. Some of the fastest-growing B2B SaaS businesses (e.g. Slack) have a low ACV in sales, but nevertheless experience immense success and are able to scale quickly.
Regardless of the way your SaaS enterprise defines and calculates ACV, an essential takeaway is to ensure that your entire finance team is on board with your method of calculation to ensure consistency and accuracy when evaluating your revenue and growth.
How to lead a high ACV subscription business
The role of the CFO is unique. When your SaaS business is growing, long-term success requires business strategies that are tied directly to the CFO who can lead the company with data, insights, and planning around pricing, revenue growth, happy customers, ACV, velocity of growth, customer acquisition efficiency, and cash flow.
As we look at the challenges of the CFO to lead a high ACV subscription business, one thing becomes clear: manual, error-prone, spreadsheet dependent tools that lack automation, artificial intelligence, forecasting and scenario planning capabilities are holding you and your business back.
Look to establish an automated, contract-based billing system to see revenue, billings, and financials all in one spot—through the contract. Using the contract as the single source for revenue, billing, and financials, you can manage a single revenue stream and automatically recognize revenue throughout the customer lifecycle.
Additionally, contract changes including renewals, upsells, down-sells and holds, drive automatic updates to revenue recognition, billing, and your financials. With an automated, flexible solution, you’ll be able to get bills out faster, decrease days sales outstanding, and free up cash to grow your business.
White paper: Confessions of a Subscription CFO
Sage Intacct Demo: Contract Revenue Management—Comply with ASC 606 and IFRS