What is ACV (Annual Contract Value) in Sales and How Is It Different From ARR

You have a myriad of metrics available to measure how well your business and revenue is growing. Software-as-a-Service (SaaS) industry businesses, such as yourself, are likely familiar with (if you haven’t encountered them already) are ACV and ARR.

Here is more on what ACV and ARR are, how they’re different, and the importance of both in your sales processes. First, here’s a look at the ACV meaning in sales.

What is ACV (Annual Contract Value) in business, and what is it used for?

Annual Contract Value (ACV) is the average revenue generated by a single customer over the span of a year from their contract. It’s a key metric for businesses with recurring revenue models—like SaaS companies—as it helps track the predictable revenue earned from long-term customer contracts.

There are a few ways ACV is used in SaaS business settings:

• Revenue forecasting, which helps companies predict their future revenue growth more accurately.
• Sales targeting and strategy often use ACV to set more realistic goals and quotas. A deeper understanding of their customer contracts helps companies better define targets for their sales reps.
• Customer segmentation, which allows businesses to segment customers based on revenue potential.
• Evaluating customer profitability, as ACV helps companies gauge customer profitability over time. For example, if a customer’s ACV is low compared to the resources spent acquiring and retaining them, it may mean it’s time to focus on other customers or readjust their approach.
• Pricing strategy, as helping companies understand how much customers are willing to pay for products can help SaaS companies improve their subscription model.

The ACV value is more than just a SaaS metric—it’s something that can be used to shape business strategy and sales and marketing techniques. From guiding sales efforts and customer segmentation to influencing pricing models, ACV plays a key role in helping businesses achieve sustainable growth while staying focused on customer value and profitability.

Here’s How to Calculate ACV

Calculating ACV is fairly straightforward. Take the total value of your customer’s contract and divide it by the number of years the contract is active. The formula looks like this:

ACV = Total Contract Value/Number of Years

For example, if a sales rep signs a contract with a customer who’s worth $120,000 over the years, the ACV would be:

ACV = 120,000/3 = 40,000

In this example, the ACV is $40,000, meaning, on average, this specific customer would generate $40,000 annually.

What is ARR (Annual Recurring Revenue), and how is it used in business?

Annual Recurring Revenue (ARR) is used primarily by businesses that use subscription models, a highly popular model in the SaaS industry. The ARR metric refers to the predictable revenue a business expects to bring in annually from its ongoing customer contracts. It gives businesses a clearer picture of how much steady, reliable income they can count on from customer subscriptions or long-term agreements.

The metric is used in a few ways, including:

• Tracking year-over-year performance
• Assessing how well companies are retaining existing customers
• Measuring the impact of upselling or cross-selling efforts
• Forecasting revenue based on a reliable, long-term view of income
• Tracking business growth
• Setting detailed sales goals
• Attracting investors or securing funding
• Allocating budget

Whether business owners are looking to scale their business and attract new investors or they just want to monitor how healthy their business is, ARR is usually the go-to metric that helps companies see their bigger financial picture.

Here’s How To Calculate Your ARR

ARR is calculated by taking the recurring revenue generated from customers over the course of a year (excluding any one-time fees, discounts, or non-recurring charges). Use the following formula to calculate ARR.

ARR = Total Monthly Recurring Revenue (MRR) X 12

Before calculating your ARR, figure out your Monthly Recurring Revenue (MRR). You can do this by identifying the recurring revenue you generate from your subscribers on a monthly basis and multiplying it by 12.

For example, if your business has 100 customers and each one is subscribed to a service that generates $500 per month, your total MRR would be MRR = 100 X 500 = 50,000.

To calculate your ARR, simply multiply your monthly revenue by 12: ARR = 50,000 X 12 = 600,000. Your ARR would then be $600,000, meaning, based on your current subscriptions, that your business can estimate $600,000 in revenue from your subscriptions every year.

ACV vs. ARR: What’s the Difference?

Now that you understand what ACV and ARR are, it’s time to think about how they’re different.

Both are used in businesses with recurring revenue models, but they serve different purposes and provide unique insights into the financial health and performance of a company.

Amount of Contracts Measured Each Year

Both metrics look at the number of contracts measured every year, though in a different way. For instance, ACV doesn’t measure the total revenue of all contracts; rather, it tells teams how much a single customer can generate every year. On the other hand, ARR looks at the total recurring revenue you can generate from all customer contracts over a year.

While ACV zooms in on a single contract or customer, ARR gives companies a broader picture of the company’s overall revenue stream from its entire customer base.

Level of Standardization

ACV sales vary widely depending on the length and term of individual contracts. Some contracts may include different pricing models, upsells, cross-sells, etc., making ACV less standardized across the board.

ARR is highly standardized because it is based on consistent, recurring revenue that comes from a company’s ongoing contracts. Regardless of whether a customer has a different pricing model or terms, ARR looks solely at the recurring portion of the revenue businesses can rely on annually.

Inexact vs. Firm Dollar Figure

ACV can be an inexact figure, while ARR is a firm, predictable dollar figure. ACV can be influenced by factors like one-time setup fees, varying contract lengths, or different service levels; ARR excludes each of these factors. Additionally, ACV doesn’t always give an accurate snapshot of the revenue generated per customer each year. ARR does. This makes ARR a more valuable metric because it gives companies a more solid, dependable revenue projection than ACV.

The Importance of ACV in Sales

With the meaning of ARR and ACV in mind, let’s discuss why ACV is so important in sales.

More Accurately Predicting Your Revenue

Because ACV helps you understand the average value of each of your contracts, you gain a clearer picture of future income from individual deals. You can use these insights to forecast revenue with more accuracy, even if you’re in an industry where one-off purchases might not provide predictable incomes.

Guiding Your Sales Strategy

Knowing ACV can help you dramatically improve your sales strategy. For example, if your average contract value is high, your sales team can focus on fewer, more strategic deals that yield higher returns. On the other hand, if it’s low, you may want to shift your sales strategy to a more volume-driven approach where the key goal is to land more deals. ACV can help guide these decisions.

Evaluating Your Customer Value

ACV software can help you evaluate the long-term value of each of your customers. By measuring roughly how much revenue someone brings in every year, you can prioritize your most valuable relationships. For example, customers with a higher ACV often require more personalized attention, while those with a lower ACV might benefit from automated engagement metrics.

Assessing the Effectiveness of Your Marketing and Sales Efforts

Using ACV to track the average value of contracts signed through your specific campaigns or strategies helps you determine whether sales reps’ efforts are targeting high-volume audiences without significant returns. A rising ACV, for instance, may suggest that your sales and marketing are working on landing bigger, more lucrative deals. A declining one might show that your strategy needs an overhaul to attract more valuable customers.

Setting Sales Targets and Quotas

ACV can help sales leaders create more realistic goals for their teams. For example, if the ACV is $50,000 and the sales goal is $500,000 for the year, your sales reps know they’ll need to close 10 deals. This straightforward calculation essentially gives your teams much-needed clarity on how many contracts they need to win and gives leadership a clear roadmap to hit revenue targets.

Improves Your Budgeting and Financial Planning

ACV is invaluable in budgeting and financial planning. You can use the metric to predict how much revenue customers will bring in throughout the year and allocate resources appropriately. If the ACV is growing, you can plan for expansion or invest in new hires. If it’s shrinking, you might need to reassess your spending and improve the value of your future contracts.

Customer Segmentation and Prioritization

Customer segmentation relies heavily on ACV. Customers with a higher ACV typically drive more revenue, so you’ll want to focus on those relationships and provide more hands-on support or tailored offerings. Lower-ACV customers might be better suited for automated service or less personalized engagement.

Tracking and Improving Your Overall Sales Performance

Finally, tracking your ACV (either with ACV software or manually) gives you valuable insights into sales performance. For example, an increasing ACV indicates your sales teams are successfully landing high-value deals, which is a strong indicator of effective selling and deal expansion efforts. If your ACV is declining, consider offering additional training or strategy adjustments for your sales teams.

Podium: Helping You Unlock the Full Potential of Your Sales Strategy With ACV

ACV is an incredibly powerful metric that can help you unlock deeper insights into customer value, guiding your sales strategies and improving your financial planning. By using ARR, you can better predict annual revenue and set more realistic goals and targets for your business. Whether you’re looking to close higher-value deals or streamline your operations, ACV gives you the clarity and insights needed to make more informed decisions for faster growth.

With Podium, taking your business to the next level is even easier. Podium includes a suite of tools that help you better engage with your customers and optimize your sales strategy. Want to learn more? Watch a demo today.