Accurately calculating financial and customer value is essential for any company striving for growth and success. Knowing the value of customers and being able to accurately predict financial position allows businesses to be selective about business strategy and make the best operational decisions.

Knowing the life time value(LTV) of customers gives businesses the ability to identify and focus on their most valuable products or highest yield customer segments, leading to increased revenue and profitability and a streamlined operation.

There are numerous metrics that organizations use to predict financial success and viability. Metrics such as Customer Lifetime Value (CLV) measures the total value that a customer will generate for a company over their lifetime, and Average Order Value calculates the average value of each order which allows businesses to accurately project and forecast revenues.

Being able to gain insights into financial and customer value allows companies to target areas of operational improvement or focus more energy on the areas that are successful. It can also be a useful metric for supporting operational improvements or reducing costs.

Using customer and financial metrics helps companies to identify and correct failing segments or operational processes. Changes can be made to meet revenue expectations or course correct parts of the operation which are getting off track.

Without these insights, companies may be uninformed or unaware of actions or activities that negatively impact the success of the operation and drain finances and ACV and ARR are tools commonly used to examine and project financial performance.

You can make money two ways — make more or spend less. 

-John Hope Bryant

Differences Between ARR and ACV?

The main difference between ACV and ARR is that ACV measures the annual recurring revenue generated by a single customer contract, while ARR calculates the total annual recurring revenue generated by all business customers.

While both metrics reveal important information, each provides a different perspective. ACV is a more detailed providing financial information specific to each customer and ARR gives a more generalized picture.

What is Annual Contract Value (ACV)?

Annual Contract Value (ACV) measures the total amount of annual recurring revenue that is generated by a customer contract. This metric helps companies understand how much revenue they can expect to receive from each customer on an annual basis and it can be used to make better financial projections and support strategic decisions in business planning.

How to Calculate Annual Contract Value (ACV)?

working on a computer and calculator getting the real ACV

Calculating ACV properly will require a couple of things.  You will need to know the total contract value and the length of the contract in years in order to calculate.

This information can then be used in the ACV formula, which is –

ACV = Total Contract Value x Length of Contract (in years)

Annual contract value can shift based on the duration or term of the contract.

  • For a long-term customer, the ACV will be higher as the length of the contract is longer.
  • For a short-term customer, the ACV will be lower as the length of the contract is shorter.

By combining the total ACV for long and short term customers, the total ACV can be calculated. The total value of a contract or TCV is the amount of the agreed payment for the life of the contract.

Your profits reflect the success of your customers. 

-Ron Kaufman

Why ACV Is an Important SaaS Metric

ACV as a Saas Metric

ACV is often used by Saas companies to monitor performance. Companies that offer products like webhosting or website building gain profits from monthly and annual subscriptions. It is important for businesses like Wix and Bluehost to use ACV because it helps them to understand how much revenue they can expect to make for each customer per year. This can be useful in terms of planning, hiring, or organizational strategy.

One of the biggest benefits of ACV is that it allows SaaS companies to predict recurring revenue with higher accuracy. ACV is calculated by multiplying the total contract value by the length of the contract in years, giving companies an accurate picture of a customer’s actual spending annually rather than using the total value of a contract (TCV).

ACV is capable of identifying and highlighting the most valuable customer segments. By understanding which ones generate the highest ACV, Saas companies can prioritize these segments and allocate their resources accordingly to drive higher profits. It provides better insight into ongoing revenue and can help Saas companies to manage ongoing growth or expansion.

What is ARR?

Annual Recurring Revenue (ARR) is a metric used to measure the total amount of revenue that a company expects to receive from its customers on an annual basis. It is calculated by multiplying the number of customers by the average revenue per customer. Annual Recurring Revenue (ARR) is the total amount of revenue that a company expects to receive from its customers on an annual basis. MRR or monthly recurring revenue is the amount that will be paid on a monthly basis.

How to Use ARR?

The growth of a company over time is one of the predictors of success and ARR helps business to understand and manage their future financial expectations. Leaders and managers can use ARR to make ongoing financial projections or plan for adjustments. It can be used to compare the performance of different companies in the same industry.

There are several ways that businesses use ARR to measure their performance and the information provided by ARR is often used to assess future performance and make strategic decisions. It is a versatile financial tool that predicts success and examines customer retention, along with highlighting certain risks and it is used in the following areas –

Growth measurement

By comparing revenue from one period to another, companies can see how their revenue is trending and make decisions about how to increase it. Predictions allow companies to assess the amount of revenue that will be accrued, which is helpful for things like resource or inventory planning. Assessing revenue for shorter time periods can be done using MRR – monthly recurring revenue.

Financial Projections

ARR can be used to make financial projections over future weeks, months, or years. By knowing the number of customers and the average revenue per customer as well as customer acquisition cost (CAC), companies can estimate how much revenue they will generate in the future and make or adjust budget plans accordingly.

Key Segments

Companies that understand which customer segments generate the most revenue will have the opportunity to capitalize on the most profitable areas. High performing segments can be prioritized, and resources can be allocated to support growth and success of individual products or accounts.

Performance

Companies can use ARR to see how their business is performing when compared to others in the industry. By comparing the ARR of different companies in the same industry, business leaders can assess performance and see how they stack up against competitors.

Churn Risk

One of the biggest revenue losses for Saas businesses is customer churn rate. Customers who fail to pay or cancel accounts and subscriptions can add up to a lot of revenue lost. Monitoring changes in the number of customers and average revenue per customer means that companies can identify those who may be considering canceling their subscription. This gives Saas businesses the chance to take appropriate steps to correct any problems and retain more customers.

How to use RCV (Receivable Collection Value) on ARR?

RCV (Receivable Collection Value) can be used in the calculation of Annual Recurring Revenue (ARR) which is a financial metric used to measure the predictable and recurring income that a company can expect to receive from its customers over a 12-month period.

To calculate ARR, your first calculation for the RCV is by adding up the total value of all unpaid invoices that are due to the company. Then you would multiply the RCV by the number of times the company expects to collect the payment within the next 12 months. For example, if a company has an RCV of $100,000 and it expects to collect the payment 4 times within the next 12 months, the ARR would be $400,000.

How to Calculate ACV and ARR?

If you are planning on using either of the two metrics discussed in this article here is a recap and of the formulas needed –

To calculate ACVs, you need to know the total contract value and the length of the contract in years. The formula for calculating ACV is as follows:

ACV = Total Contract Value x Length of Contract (in years)

To calculate ARR, you need to know the number of customers and the average total revenue per customer. The formula for calculating ARR is as follows:

ARR = Number of Customers x Average Revenue per Customer

Focus on maintaining relationships with your customers, revenue will look after itself. 

-Janna Cachola

Key Takeaways

Both B2B and B2C Businesses need to be able to accurately predict or assess their financial position in order to make fully informed decisions and plan for the future. This includes forecasting revenue and expenses, identifying potential financial risks and opportunities, and measuring the overall health of the company.

Accurate financial predictions and assessments also provide transparency and accountability to stakeholders, such as investors, lenders, and customers.

For these reasons, ACV and ARR can be useful tools to provide financial information and some key takeaways are –

  • ACV is a metric used to measure the annual recurring revenue generated by a customer contract.
  • ACV is a component of ARR, which measures the total annual recurring revenue generated by all customers.
  • ACV is important for SaaS companies because it helps them to understand how much revenue they can expect to receive from each customer on an annual basis.
  • ARR provides more general information for customer activity
  • ARR can be useful for growth measurement, business planning, and churn reduction

ARR can be used to measure the growth of a company over time and to make financial projections.