Let’s break down the difference between ACV (Annual Contract Value) and ARR (Annual Recurring Revenue) in a way that’s easy to understand.
They are often used by businesses that offer services like software or telecoms, where customers sign contracts for some time.
Even though ACV and ARR might seem a bit similar, they’re actually quite different, and we’re here to explain how they don’t mean the same thing. So, keep reading to become an expert on the topic!
What is ACV?
ACV is the “Annual Contract Value” you have with your customers. This includes all the money a business gets, like regular payments, extra stuff they buy, and upgrades.
It helps businesses figure out how much money they make from a customer’s contract in a year.
ACV vs. ARR
ACV and ARR are important tools for businesses to understand their money, but they work in distinct ways.
Annual Contract Value (ACV)
As we said, ACV is all the money – net sales – a company gets from customers in a year.
Business can keep an eye on where their money comes from and make smart choices about prices, improving products, and planning their marketing strategies.
Annual Recurring Revenue (ARR)
On the other hand, ARR is about how much money you make in a year from subscriptions.
It’s like counting the money you get from selling video game memberships in a single year. In other words, ARR is predicts how much money a company will make in a year from subscriptions and recurring payments.
In a nutshell
ACV looks at the money a company gets all at once, while ARR looks at how money keeps flowing in regularly from a subscription. Both help businesses make decisions and have a steady income.
ACV Pros and Cons
ACV Pros:
Tracks Sales and Marketing Success: ACV helps a company figure out if their sales and marketing plans are working. It’s like using a scorecard to see if your favorite sports team is winning or losing.
Helps with Planning: It’s like budgeting your allowance. ACV lets businesses plan how much money they’ll make in a year. This helps them decide what to spend and save for future needs.
Encourages Keeping Customers Happy: ACV shows how much money a company expects to get from customers who stay with them for a long time. This encourages the company to provide great service to keep those customers happy.
Comparing with Others: Companies can use ACV to see how well they’re doing compared to their competitors. It’s like checking if you’re running faster or slower in a race.
Easy to Understand: ACV gives a simple number that anyone can understand. It’s like telling your friends how many marbles you have; everyone gets it.
ACV Cons:
Takes Time to Figure Out: Calculating ACV can be a bit like counting all the stars in the night sky. It takes time and effort.
Leaves Out One-Time Earnings: ACV only looks at money that comes in regularly, like your weekly allowance. It doesn’t count one-time money, like birthday gifts.
Doesn’t Show the Whole Picture: ACV is just one piece of the puzzle. It’s like having one piece of a jigsaw puzzle but not the whole picture.
Assumes People Won’t Change: ACV assumes that customers will keep using a service or product the same way, even if things around them change. But people can change their minds, and ACV doesn’t show that. It’s like thinking your friends will always play the same games with you, but sometimes they want to try something new.
ARR Pros and Cons
ARR Pros:
Stable and Predictable Income: ARR is like having a steady allowance every week. It helps companies know how much money they’ll get regularly, so they can make plans for the future.
Higher Value to Investors: Companies using ARR are like favorite teams that always play well. Investors trust them more because they know the company will make money consistently.
Keeping Customers Happy: ARR helps businesses keep their customers happy because they’ve already committed to buying something. It’s like knowing your friends will come over to play because they paid for a fun game.
Making Better Things: ARR helps companies plan what new toys or games to make. They can make their current stuff better and create new things. It’s like knowing which games your friends like and making those games even more fun.
Better Money Management: ARR is like knowing how much you’ll get for your birthday. Companies can decide how to spend and save their money, so they’re always ready for special occasions.
ARR Cons:
Pressure to Keep Customers: Companies with ARR need to make sure their customers stay happy. It’s like keeping your friends interested in playing games with you. If they stop, it can be a problem.
Changing Prices is Tricky: If a company using ARR wants to change how much something costs, they need to be really careful. It’s like slowly turning up the volume on your music so it doesn’t startle you.
Less Flexibility: ARR is like a train track that goes in one direction. It’s not easy to quickly switch to a different path. Companies might have trouble making new things if they’re too focused on what they’re already doing.
How to calculate ACV
Calculating ACV is a bit like figuring out how much money you make every year. Here’s how you can do it.
Add up all the Contracts: First, you need to add up the total money from all the contracts you got in one year. This includes new contracts and old ones that got extended.
Divide by Years: Then, you divide that total money by the number of years those contracts last. If most of them are for two years, you divide by two.
ACV = Total Contract Value ÷ Number of Years
For example, if you got contracts worth $1 million in a year, and most of them are for two years, your ACV is $500,000. It’s like figuring out that you make $500,000 every year.
Sometimes, instead of looking at the whole business, companies also calculate ACV for each customer. This helps them know how valuable each customer is and how well the business is doing.
How to calculate ARR
Calculating ARR is like figuring out how much money a company expects to get every year. Here’s one way to do it.
Add up all the recurring money: First, you add up all the money that keeps coming in every month, like subscriptions or fees for services. This means you don’t count money that only comes in once.
Divide by Customers: Then, you divide that total money by how many customers or subscribers you have. This way, you find out how much money you get from each customer in a year.
ARR = Annual Recurring Revenue ÷ Number of Customers
For example, let’s say a software company has 500 customers. They pay $100 every month for a subscription. That’s like $50,000 in a month (500 customers x $100). In a year, that’s $600,000 (because there are 12 months in a year).
When you divide that by all 500 customers, you find out that the average money they bring in a year is $1,200. So, it’s like figuring out that each customer is worth $1,200 every year to the company.
In conclusion, whether you’re aiming for ACV or the steady income of ARR, these metrics are your guide to prosperity.
