ARR vs ACV: What Is The Difference Between These Metrics?

April 15, 2022

There are many acronyms used in the SaaS industry, including LTV \(lifetime value), CAC (customer acquisition cost), MRR (monthly recurring revenue), ARR (annual run rate), and ROI (return on investment). Two common terms are ARR and ACV. What is the difference between ARR vs ACV?

This article will clarify the confusion surrounding ARR vs ACV or annual rate run and annual contract value, and how to calculate each metric.

ARR vs ACV: What is the difference?

What is your company’s annual recurring revenue (ARR)? This figure represents the amount of money that you can expect to receive on a yearly basis from customers who have subscribed to your products or services.

Meanwhile, your company’s average customer value (ACV) may be helpful in determining how much each customer is worth to your business.

ARR can be viewed on a company-by-company basis to gauge size. ACV (average customer value) normalizes that revenue over a period of time.

ACV examines one customer and determines the expected payout over a calendar year. For example, if a customer signs a five-year contract for \$50,000, the ACV for a single calendar year would be \$10,000.

How to track ARR and ACV in real life

Now that you are familiar with ACV and ARR, let’s take a look at an example.

Let’s suppose you have three customers:

• Customer A pays \$500/year for 1 year
• Customer B pays \$400/year over 2 years
• Customer C pays \$300/year over 3 years

ACV

The ACV formula is quite simple. It is the total contract value minus one-time fees, divided by the total years of the contract.

(Source)

Let’s break it down, year by year.

in the first year, all three customers will pay you.

Year 1: (\$500 + \$400 + \$300) / 3 = \$400

Your ACV for the first year is \$400 but drops to \$350 in the second year due to fewer customers.

Year 2: (\$400 + \$300) / 2 = \$350

Because you have only one customer remaining on your contract, your ACV drops even further in the third year.

Year 3: \$300 / 1 = \$300

ARR

The formula for ARR is (overall subscription costs per year + recurring revenues from add-ons and upgrades\) – revenue lost due to cancellations. ARR is not divided like ACV.

(Source)

Your ARR for the first year is \$1,200. It’s a sum of all the customer payments.

Year 1: \$500 + \$400 + \$300 = \$1200

Your ARR for the second year is only \$700 because you have one less customer.

Year 2: \$400 + \$300 = \$700

Your ARR for the third year is only \$300 because you only have one customer.

Year 3: \$300 = \$300

Because the ARR metric is based on momentum, it is important to keep it as pure as possible.

These factors should be included in the calculation of ARR.

• Yearly revenue from customers
• Cancellations (churn)

When to track ARR or ACV

Calculating ACV and ARR will result in different numbers. So, when should you track each metric?? Although ACV isn’t a very useful metric, it can be combined with other SaaS metrics to provide valuable insights. You can track ARR on its own.

Let me explain the nuances.

Calculate ARR to measure year-on-year growth

the ARR tracker is an essential tool for subscription companies, providing a high-level overview of your business and allowing you to calculate the growth rate you need to continue building on your success. recurring revenue is crucial for sustaining momentum and compound growth.

ARR also includes monthly recurring revenue, or MRR. You can plan for both the short- and long-term by tracking both MRR as well as ARR.

Calculate ACV to measure customer su`ccess and sales team performance

ARR measures growth on a year-over-year basis, while ACV measures performance over time.

The ACV calculator can help you determine your marketing and sales strategy, as well as how much you should invest in each. Subscription businesses can be successful with either a low or high ACV; however, it is important to know your business’s goals. A lower ACV means you will need more customers but may have a higher return on investment (ROI).

Churn rate

It is crucial to know when customers are churning. Churn rate is an indicator of the value of your product and the features you offer to customers. Therefore, it is important to keep track of when churn occurs.

(Source)

Churn is the percentage of customers who cancel their service within a certain time period.

Churn rate = number of churned customers divided by the total number of customers.

Churn rate is an important metric to track, but it’s only the beginning. Once you have calculated your churn rate, it’s time to investigate the root causes.

MRR

Monitoring your company’s monthly recurring revenue (MRR) is essential for financial forecasting, planning, AND measuring growth and momentum. Because MRR is predictable and consistent, it is possible to make accurate financial projections in SaaS. MRR is a key indicator for the company’s growth. It’s like looking at your growth under a microscope.

MRR can be calculated in four steps:

• Align your data
• Break down by cohort
• Calculate MRR growth

CAC

(Source)

The customer acquisition cost (CAC) is the total cost of marketing and sales efforts required to acquire new customers. A lower CAC relative to the lifetime value of a customer (LTV) indicates a more successful business model.

CAC = Total cost of sales and marketing divided by the number of customers acquired

If you spend \$36,000 to acquire 1,000 customers, your customer acquisition cost (CAC) is \$36 per customer.

LTV

Finally, there’s customer lifetime value. The customer lifetime value (LTV) is the total dollar amount that a customer is likely to spend on your product over the course of their account.

Different LTV models can help you predict how much you will pay to acquire a customer, the effects of losing customers, and how changes in your product can affect your total revenue.

The lifetime value (LTV) of a customer is a metric used to assess the overall health of a product’s revenue and customer retention. A growing LTV means that customers are happier and will give more money over the course of their relationship with the company. A falling LTV means that the company is not getting as much from each customer, and changes must be made.

What is the difference between ACV and TCV?

Annual Contractual Value (ACV) refers to the value of a contract over the course of a year. This metric is used to normalize bookings and compare them on an annual basis. Total Contractual Value (TCV), on the other hand, takes into account all payments that will be made under the terms of a contract, regardless of when they are scheduled to occur.

Why do companies use ARR?

Annual recurring revenue (ARR) is a key metric used by both established businesses and startups to gauge progress, predict future performance, and measure momentum. ARR helps assess new contract growth, upgrades, upsells, and renewals, as well as churn and downgrade metrics.

Why ARR is crucial for SaaS businesses?

SaaS businesses that have term subscription agreements with customers need to know their annual recurring revenue (ARR). This is a critical metric. SaaS companies calculate ARR in order to gain insight into their term subscription agreements and how they are performing each year.

Conclusion

It is important to have a clear and consistent way to calculate ARR vs ACV for your company, especially if you are running a SaaS business. This will help ensure that everyone is on the same page and using the same metrics.

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