How to Estimate and Use Annual Contract Value – A Comprehensive Guide

Today’s advanced SaaS businesses have taken the entire customer experience into the virtual world. Furthermore, they have access to SaaS metrics as well.

If you have a proper setup to estimate and analyze data, you can get enough information to use for the benefit of your company. For example, if you compare the data analytics of modern-day tools such as Baremetrics with the 1990s’ ERP tools, the modern one will definitely give you better results. 

If we look 2 decades back, enormous upfront costs were required to have data analytics tools. Therefore, only big corporations can use such tools. But nowadays, the internet has given every type of business access to all tools and programs.

Modern SaaS metrics such as ACV, TCV, MRR, ARR, LTV, ARPU, and churn give loads of information about what’s going on in your company. 

Annual contract value or ACV can be used to add value to your business. But how?

Decoding Annual Contract Value 

ACV is simply the average annual revenue you generate from each customer contract. It is not included in standardized metrics as there is no generalized method for calculating it.

Examples of ACV

Example 1: Suppose you are running a B2B SaaS business. You managed to sign a 5-year contract with 4 new customers. Each one has to pay you $6000 biannually. The ACV for each contract will be $12,000.

Example 2: Now imagine a B2C company that has launched a new gaming app. It managed to get 300 customers with each paying $70 every month. The ACV in this case will be $840. 

What Makes ACV a Notable Metric?

As an individual metric, ACV may not be noteworthy for your SaaS business. This is because the growth and development of your business are independent of ACV. It depends completely on the nature and size of your business.

Unusually B2B companies tend to have greater ACV than  B2C ones. The reason is straightforward. Ordinary customers cannot pay huge amounts for your services or products.

If B2C companies manage to attract millions of users, they can grow into big corporations and SaaS businesses with an ACV of less than $200. Netflix is the prime example of such a SaaS company that is now a million-user company. 

ACV, higher or lower, has little to no impact on your business except it’s challenging to build a company with your products and command smaller annual contracts.

When you link your company’s ACV with some other metrics, it becomes important. Customer acquisition cost (CAC) and customer lifetime value (LTV) are two key metrics that can be paired or compared with ACV to get useful data analytics. It can be very useful for you especially when you are starting your company. It gives you information about the value of your contracts and indicates the marketing efficiency and profitability of your strategies.

Calculating ACV-The Nitty Gritty Details

There are a couple of ways to calculate the ACV for your contracts. You can use any one of them based on the data you have. 

You can use ACV for benchmarking your company against other similar companies. However, you need to follow the Apple Vs Apple formula when benchmarking. In simple words, you can compare your company with companies having nearly similar ACVs. Furthermore, you need to use the same formula for calculating the ACV of each company.

ACV is not a standardized or generalized formula to get an idea about revenues like ARR or MRR. Still, some SaaS companies use it to estimate revenue. Before calculating ACV, all types of setup fees and additional charges are excluded. The key charges to exclude are:

• Setup costs
• Installation services
• Initiation fees
• Onboarding charges

Let’s go through the methods to calculate ACV.

Method No. 1 

In this method the total contract revenue or simply TCV is divided by the total number of years the contract is expanding on. It is super effective for calculating the ACV of long-term contracts. 

Example: If you signed a 4-year contract with TCV of $60,000. Setup charges for this contract are $500, which are charged separately. The ACV for this contract will be $15,000. 

Method No. 2

Contrary to the above one, this method is useful to estimate the ACV of short-term projects. In this method, you have to annualize the TCV for each contract. 

Example: If you signed a 3-month contract with a TCV of $5000, you need to multiply it by 4 to annualize it. So the ACV will be $20,000. When using this method, you have to assume that the contract will be renewed automatically for at least a year.

Understanding the Significance of ACV in SaaS Business Operations

It has already been mentioned that ACV is not a Noteworthy metric as an individual. It is valuable for your business only when you combine it with some other metrics. Doing so can provide you with some essential information that allows you to work on your strategies and grow your business.

Once again, we are mentioning that low or higher ACV has no impact on your business growth and development. It all depends upon the size of your business, strategies you made for progress, and execution of plans.

The most important SaaS metrics you can compare or pair with annual contract value are: 

1. Customer Acquisition Cost (CAC)
2. Annual Recurring Revenue (ARR)
3. Total Contract Value (TCV)

However, the main point is what insights can comparing ACV with these metrics provides you and how it can be helpful for the growth of your company. Let’s find out.

CAC and ACV

CAC is the amount you have to spend to get a new customer or contract. Comparing it with ACV can tell you how much time it will take you after signing a contract to earn back the amount of signing a new contract or grabbing a new customer. For example, if you signed a new contract for $5,000 and CAC is $8,000, then CAC to ACV ratio will be 1.6. So, it will take you 1.6 years to earn back the amount to win a new deal or contract.

There are reasonable chances that you may not earn back that amount. The reason is the churning of your customers. Often customers don’t stick with you in case of long-term projects. Most of them leave you before you reach the payback. 

By this comparison, you can understand the worth of different customers or contracts and can spend accordingly to get them. For example, you will not spend a lot on a contract where the chances of earning back the amount of winning a new customer are low.

TCV and ACV

Both these metrics are closely related. TCV is the total value of the contract and ACV is the annual version of the same contract. For example, if you signed a 3-year contract with $90,000, and all extra charges are excluded from it, then TCV is $90,000. On the other hand, ACV is $30,000, which is the annual version of TCV.

It normalizes the customer contract terms and offers a visible customer comparison. If ACV and TCV are almost similar for your SaaS company, it means most of your customers go roadside after the first year of the contract. It’s time to focus on your company’s churn rate and try to reduce it.

ARR Vs ACV

Many times these two metrics are confused with each other. The reason behind the confusion is that both are based on annual terms and are related to the revenue of your company. However, the fact is not that, they are just closely related and have several different traits.

The key difference is that ACV is the revenue of a single contract and ARR is the revenue of the whole company. When calculating ARR, it is assumed that nothing changes in your company for a whole year.

Using Baremetrics to Calculate ACV

There is no generalized formula for ACV calculation, therefore, Baremetrics cannot calculate it directly for you. However, you can get customers’ contract data from this tool and then calculate ACV using that data. Based on the new customers you signed and the MRR of these customers, you can calculate ACV. 

To calculate ACV, you need to perform the following steps after entering the dashboard of Baremetrics.

Step #1: Create a new worksheet and give it the title “ACV”

Step #2: Add references for new customers you signed and MRR your company generates from them. 

Step #3: Now add a custom metric with the following formula.

Formula=({new_customer_mrr}*12)/{new_customers})

This is the formula you can use to estimate the ACV.

In the Baremetrics dashboard, you can add different comparisons as well like ACV Vs TCV, ACB Vs CAC, etc. to keep track of these comparisons. 

Now, how can you better use data analytics to improve marketing and other strategies of your business that can boost profitability? Baremetrics can help you in this regard. Sign up now and enjoy its free trial to better understand these metrics.