According to Statista, the SaaS market was estimated to be worth over $146 billion in 2021. By 2022, the market had reached more than $167—and currently, it’s estimated to be worth over $195.
No doubt, the Software-as-a-Service business model is growing rapidly and is a popular way for tech startups to effectively introduce new products to market and grow.
However, to achieve business growth, manage your sales effectively, and overall business success, there are many subscription metrics to track—and this can be confusing for most SaaS company owners.
Don’t fret.
Thus, it’s important to understand the difference between them.
In this article, I’ll compare ARR vs. ACV to help you understand where each metric is useful, and how to calculate them to know how well your company is performing.
Pro tip: To run a successful subscription-based business model, you need to understand what tools to use, how the model works, etc. This comprehensive Younium guide can greatly help you.
Let’s get started.
What is ARR?
ARR, otherwise known as Annual Recurring Revenue, is a vital B2B SaaS subscription revenue-related metric that indicates the total recurring revenue your company is generating from all your customer subscriptions each year.
Within this metric are other vital KPIs such as annual revenue per user and customer lifetime value.
When Should You Leverage ARR?
Annual Recurring Revenue is a useful metric to track to determine your company’s yearly growth.
This metric focuses exclusively on the total amount of all types of revenue obtained from all types of recurring subscriptions in a year.
Typically, you can use ARR in the following ways:
- To calculate the total amount of annual recurring revenue.
- To get a comprehensive view of your company’s cash flow to improve your cash flow.
- To make informed future predictions and long-term investments.
- ARR focuses on revenue from yearly subscriptions and not one-time purchases hence it can be useful for determining the success of your subscription model.
- Tracking ARR for different years can help you determine how different marketing decisions and campaigns impact your overall business growth.
Furthermore, Annual Recurring Revenue can be useful in the following situations:
- Determine annual recurring revenue from new subscriptions
- Evaluate recurring revenue from current customers
- How much your annual recurring revenue has increased after adding new features and upgrades.
- Identify a decrease in annual recurring revenue due to downgrades in value.
- Determine the percentage of loss of revenue stream on an annual basis.
- Informing existing or potential investors about your company’s annual growth.
ARR isn’t a metric for making short-term company decisions.
Pro tip: To minimize costly errors when sending invoices to your customers, find a robust recurring billing software. If you are not sure how to choose the right software for your business, read this Attrock article to understand how to find a great solution for your business.
How to Calculate Annual Recurring Revenue
ARR is a standardized B2B SaaS revenue metric than ACV.
Here is the standard formula for calculating Annual Recurring Revenue.
What is ACV?
Otherwise known as Annual Contract Value this SaaS subscription metric is used to measure the yearly revenue generated from an ongoing customer. It can also be used to track monthly, quarterly, or semi-annual revenue generated from an ongoing customer.
Simply, this metric helps you determine how much a single customer is worth each year.
You can value your customer’s accounts based on the following:
- Recurring monthly revenue
- Plans with varying costs
- Multi-annual contracts
When Should You Leverage ACV?
Unlike the ARR metric that helps to measure a company’s revenue growth and overall success, ACV measures your sales/marketing and customer success performance.
You can use ACV in the following scenarios:
- Evaluate your team’s marketing campaign success in terms of demand generation.
A high ACV for a single customer or multiple customers shows that your marketing team is generating demand and attracting many customers to sign contracts.
- To measure the revenue generated from a single customer to determine the value they bring to your company.
- To make precise comparisons of the revenue generated by customers in different contracts.
To use ACV for company growth, you need to actively:
- Prioritize valuable accounts
- Evaluate the performance of your sales reps in huge company deals
- Assign the right resources to valuable company deals
- Plan promotional strategies to target exclusive industries
How to Calculate Annual Contract Value (ACV)
To compute ACV, you must find out the Total Contract Value (TCV) first.
Here is how to get the TCV.
Then calculate ACV as follows:
Want to start your SaaS subscription business but aren’t sure where to start? This SmallBusinessHQ post shares a list of business formation services to help you get started easily.
ARR vs. ACV: What’s The Difference?
Both ARR and ACV are vital metrics for SaaS subscription companies to track.
They provide valuable insights into the health of a company.
However, the difference is in the way they measure revenue—and this is something worth understanding, especially for startups looking to grow their companies.
Here are the key differences between the two metrics:
- Annual Recurring Revenue (ARR) is used to find out the total revenue value of all subscription-based accounts.
On the other hand, Annual Contract Value (ACV) helps companies to determine the annual value of a single subscription account.
- The ARR formula is standardized whereas the ACV formula can be varied by including one-time fees or not.
- ARR can be used as a standalone subscription metric to determine revenue growth or loss. On the other hand, ACV is best used with other metrics.
- ARR is a powerful, long-term, and strategic metric. ACV is a timely, actionable, and short-term metric.
Overall, you should use both metrics and track them over time to obtain a comprehensive picture of your SaaS subscription business’ health.
By monitoring ARR and ACV, you can determine whether your company is doing better in terms of sales, revenue, and customer satisfaction or whether you need to improve.
Author Bio – Reena Aggarwal
Reena is Director of Operations and Sales at Attrock, a result-driven digital marketing company. With 10+ years of sales and operations experience in the field of e-commerce and digital marketing, she is quite an industry expert. She is a people person and considers the human resources as the most valuable asset of a company. In her free time, you would find her spending quality time with her brilliant, almost teenage daughter and watching her grow in this digital, fast-paced era.
