ARR vs ACV (Which one should you track?)

Annual Recurring Revenue (#ARR) and Annual Contract Value (#ACV) are two critical metrics for measuring the success of a SaaS company. ARR represents the annual revenue from a company's subscription-based products or services. In contrast, ACV, on the other hand, is the value of subscription revenue from each contracted customer normalized across a year. While both metrics are significant, several critical differences between ARR and ACV can impact a company's valuation.

1. Recurring Revenue vs. One-Time Revenue: One of the most significant differences between ARR and ACV is that ARR represents recurring revenue generated by a company's existing customers and any new customers acquired during the year. This means that ARR is a more accurate representation of a company's ongoing revenue stream, which is a critical factor in determining a company's valuation.

ACV, on the other hand, only represents the total value of a customer's contract over a year, regardless of whether the customer renews their contract in the future. This means that ACV can be misleading, as it does not consider the ongoing revenue generated by a company's existing customers.

2. Forecasting Future Revenue: Another vital difference between ARR and ACV is their ability to forecast revenue. ARR is a forward-looking metric that can forecast a company's future income based on its existing customer base and anticipated growth. This makes it a more valuable metric for investors, as it provides insight into a company's future revenue potential.

ACV, on the other hand, is a backward-looking metric that only represents past revenue generated from customer contracts. While ACV can be used to forecast future revenue to some extent, it is less accurate than ARR and may not provide a complete picture of a company's future revenue potential.

Impact on Valuation

The differences between ARR and ACV can significantly affect a company's valuation. Because ARR represents ongoing revenue generated by a company's existing customer base, it is generally considered a more valuable metric than ACV. This is because ARR provides a more accurate representation of a company's future revenue potential, which is a critical factor in determining a company's valuation.

Let's Calculate the Difference!

Let's assume a SaaS company has 100 customers who each signed an annual contract for $1,200. The company has not acquired any new customers during the year, and all customers renewed their contracts at the end of the year. In this scenario, the ARR and ACV for the company would be as follows:

ARR: The company's total recurring revenue for the year is $120,000 (100 customers x $1,200 annual contract value). The ARR is also $120,000 because the company did not acquire any new customers during the year.
ACV: The total contract value for the company's customers is $120,000 (100 customers x $1,200 annual contract value). Since all customers renewed their contracts at the year's end, the company's ACV would also be $120,000.

Now, let's assume that in the following year, the company acquired 50 new customers, each signing an annual contract for $1,200. The existing 100 customers all renewed their contracts, and the company did not lose any customers. In this scenario, the ARR and ACV for the company would be as follows:

ARR: The company's total recurring revenue for the year is $180,000 (150 customers x $1,200 annual contract value). The ARR has increased by $60,000 because of the addition of 50 new customers.
ACV: The total contract value for the company's customers is $210,000 (150 customers x $1,400 average contract value). The ACV has increased by $90,000 because of the addition of 50 new customers and the increase in the average contract value.

This example shows that the ARR and ACV metrics are both important but represent different aspects of the company's revenue stream. ARR provides a more accurate representation of the company's ongoing revenue stream and growth potential, while ACV offers insight into the value of individual customer contracts. A company with a strong ARR is generally considered to have a more valuable revenue stream and may be more attractive to investors. In contrast, a company with a high ACV may have a more valuable customer base. In conclusion, while ARR and ACV are important metrics for measuring a SaaS company's success, several key differences between the two can impact a company's valuation. ARR provides a more accurate representation of a company's ongoing revenue stream and future revenue potential. At the same time, ACV only represents the value of a customer's contract over the course of a year. As a result, investors may place a higher value on companies with a strong ARR, as it provides a more complete picture of a company's future revenue potential.