How to calculate annual contract value (ACV)
Part of why ACV is confusing for SaaS founders is because it feels very similar to ARR on the surface. But while ARR measures the value of recurring revenue from upsells, renewals, and other momentums at a single point in time, ACV normalizes that total revenue across one or more years.
Let’s go over two different examples to show how you can calculate ACV for your own business, whether your customers prefer long- or short-term contracts.
ACV for a long-term customer
Meet Customer A. They recently signed a 3-year contract worth $60,000 with your company (congratulations!), with an initial signup fee of $150. Customer A plans to pay yearly for your software.
The ACV for Customer A, then, can be calculated as follows:
It’s worth noting here that in this case, ACV and ARR are identical—we’ll see why in a minute. Also, ACV is typically calculated only by the value of the contract, and does not include any one-time fees involved with activation, like implementation fees.
ACV for a short-term customer
Let’s move on to Customer B, who agrees to pay $5,000 for a 6-month contract, paying monthly. Since payments are normalized over one year instead of the length of the contract, the ACV for Customer B is calculated thus:
In this case, assuming Customer B plans to renew at the end of the six-month period, the ARR would be $10,000 over the course of their first year.
Combining ACV for both customers
This is where things get interesting. Let’s now average our ACV for both Customers A and B.
First, we need to work out the ARR so we can show the difference between how to calculate ARR and ACV. This value gets normalized across the length of each contract, to obtain the ACV for each year:
Now you can see that ACV lets you average out the annual values of contracts across different customers, giving you a great tool to measure the health of your subscription-based business.