ARR vs ACV vs TCV

What comes to your mind when you read the letters ARR?

Well, if you’re in the financial market you may refer to the NYSE:ARR stock, if you’re a tech guy you may think of Application Request Routing; but for us SaaS professionals, ARR means two things only: Annual Run Rate and Annual Recurring Revenue.

Although both metrics are related to your business revenue, they mean two very different things.

Annual Run Rate

Annual Run Rate is a term used to describe annualized earnings extrapolated from a shorter time frame. We usually use the run rate to estimate future revenues or to represent the size of a business in terms of annual revenues.

Let’s say your company had $100,000 in earnings in January; you could say predict that your annual run rate for that year would be $1,2000,000 by simply multiplying $100,000 * 12.

But run rates may cause inaccurate projections. If the time period used to calculate the run rate is not indicative of normal revenues, then the annualized earning could either be overstated or understated. For instance, some retailers experience higher sales during the holiday seasons and lower sales during summer months. If a retailer uses December sales as the basis for the run rate, sales will be overstated. If the retailer uses July sales as a run rate, sales will be understated.

The same thing applies if a company relies too much on large deals, that might be closed once or twice a year.

Finally, run rates often fail to account for sales growth. If the company has the ability to grow sales during a year, then annualizing the revenue for an average time period will fail to take into account that revenue growth.

Annual Recurring Revenue

Recurring means there’s a subscription in place and the customer is charged on an ongoing basis, rather than a one-time purchase. As we’ve discussed on this article, Annual Recurring Revenue would simply be your Monthly Recurring Revenue multiplied by twelve months.

Just like MRR, ARR will include only committed and fixed subscription or recurring fees. ARR always excludes one-time fees and usually excludes any subscription consumption or variable fees.

Unlike MRR, which is a metric that can vary dramatically from real monthly revenue due to the variance in days in the month, ARR can correlate well with actual revenue if your subscriptions are in annual or true multi-year intervals.

You may see some sources refer to Annual Recurring Revenue exclusively for multi-year contracts only. That can make sense for scenarios where customers can subscribe to whatever-they-want month intervals, but not much for SaaS where monthly and yearly plans ar more of the norm.

Annual Recurring Revenue = Monthly Recurring Revenue * 12

Accrual Accounting

If your company’s earnings comes only – or mainly – from subscriptions, you may think Annual Run Rate and Annual Recurring Revenue are not that different, but let’s see why that’s not true. In SaaS and subscriptions businesses in general, we tend to use accrual accounting.

Accrual accounting recognize revenue as it is earned, rather than when it is paid to the company.

It’s an accounting method that measures the performance and position of a company by recognizing economic events regardless of when cash transactions occur.

The general idea is that economic events are recognized by matching revenues to expenses (the matching principle) at the time in which the transaction occurs rather than when payment is made – or received. This method allows the current cashflow to be combined with future expected cashflow to give a more accurate picture of a company’s current financial condition.

This is the opposite of cash accounting, which recognizes transactions only when there is an exchange of cash.

A practical example

Here’s a sample of data to help you understand these metrics in a practical way.

Considering we’re using the accural cccounting method, let’s analyze the following data set:

 Metrics 01/2015 02/2015 03/2015 04/2015
Bookings $1,260 $1,440 $1,300 $720
Revenue $160 $280 $480 $540
Billings $1,260 $1,500 $1,360 $880

More details on this sample data set here.

The first thing to notice here is that Billings don’t really make any difference for us. If we were using the cash accounting method we’d recognize the sum of billings as our earnings, but since we’re using accrual accounting it can be ignored.

Annual Run Rate

If you sum up the revenues you can state that our Q1 earnings were $920, and therefore our Annual Run Rate will be $3,680 (Q1 earnings * 4). Notice that we’re considering that the performance of the next three quarters will be exactly the same as the first quarter of the year.

Annual Recurring Revenue

A simple way to calculate the Annual Recurring Revenue would be $540 * 12, which is $6,480. Of course this number will change as you book more revenues and your recurring revenue grows over the year.

Notice that it makes no difference if your customers are subscribing to monthly or yearly plans, since the yearly subscriptions are recognized ratably over the time of the subscription – and at the end – we’re working with monthly values only.

Annual Contract Value

Another important annualized metric to keep track of is the Annual Contract Value, or ACV.

ACV  measures the value of the contract over a 12-month period. So let’s say a customer commits to a 24-month contract of $120,000. Considering this money will be recognized as revenue ratably, we’ll have $5,000 in MRR and therefore $60,000 as your ACV.

Total Contract Value

TCV on the other hand is the total value of the contract, and can be shorter or longer in duration.

A important thing to notice is that TCV is not only about recurring revenue. It should also includes the value from one-time charges, professional service fees, and recurring charges.

Let’s say a customer commits to a 6-month subscription plan of $100/mo, your TCV would be $600. Now if the customer commits to a 24-month subscription, your TCV would be $2,400.


Leo Faria
About the author: Leo Faria is a SaaS and analytics expert. CEO and founder of Saasmetrics, a subscription analytics platform that help companies to keep track of all the important metrics of their businesses. Get your free copy of my latest book “The essential SaaS metrics guide“.

Saasmetrics is a subscription analytics platform that helps you to keep track of all the important metrics of your business.
  • Alyssa Filter

    Hey Leo – can you confirm whether ACV should include one time charges/PS as well? If not, what is the difference between ARR and ACV – seems to me there isn’t any difference if you don’t include one off.

    • Trevor Hatfield

      @alyssafilter:disqus Annual contract value (ACV) typically maps to an annualized bookings number. For companies that also charge one-time fees in conjunction with recurring fees, the first-year ACV might be higher than later-year ACVs in a multi-year contract. It is an average annual contract value of your account subscription agreements.

      Here is an example of ACV vs ARR calculated with 3 example customers:

      Customer A

      Customer A agrees to a $1000 / year 1 year agreement and pays monthly.

      Metrics calculated for Customer A Only:

      ARR = $1000
      ACV = $1000

      Customer B

      Customer B agrees to a $750 / year 2 year agreement and pays yearly.

      Metrics calculated for Customer B Only:

      ARR = $750
      ACV = $750

      Customer C

      Customer B agrees to a $500 / year 3 year agreement and pays yearly.

      Metrics calculated for Customer B Only:

      ARR = $500
      ACV = $500

      ——————–

      Metrics calculated with all three customers A, B & C combined:

      ARR = $2,250

      ACV=
      Year 1= $750
      Year 2= $625
      Year 3= $500

      ——————–

      Calculations broken down:

      ARR: ($1000 + $750 + $500 = $2,250)

      ACV=
      Year 1: ($1000 + $750 + $500 / 3 = $750)
      Year 2: ($750 + $500 / 2 = $625)
      Year 3: $500 / 1 = $500)

      • Alyssa Filter

        Thanks Trevor. Why would the Year 1 ACV divide the annual amounts by 3? (same in year 2). It seems like they should just be adding the 3 to get the annualized contract value since those are listed as annual rates.

        Can you also please provide a similar example with one time services such as implementation fees, onboarding fee, training, etc. that could be typically seen bundled with year 1 contracts?

        • Trevor Hatfield

          First let me start by saying this is a pretty lengthy reply and ACV tracking and calculation is never really unanimously agreed upon, even by major SaaS businesses who do seem to know what they’re doing. This causes some pretty serious confusion. I would mostly suggest that whether you calculate it how I suggest, or in your own way, that your company is all on the same page with how you are coming to your calculation. I will answer your questions and give you examples as to why and also why you, and all of us, are probably confused.

          1. ACV is how much, ON AVERAGE, your annual value of a given contract type across all customers of the period is worth. This is the primary difference between ACV and ARR. If you were to add them it would come out to the same calculation as ARR just with a different way of getting there. HubSpot’s ACV is around $6,000 – $10,000 (just a guess). It would be much higher if you were to add all of the signed committed agreements for the year, lets say 1000 contracts x $10,000 = $10M, quite a difference.

          ACV BOOKINGS however refers to the total value of accepted term contracts in which you would add them together vs average them and this is only for 1 year. Form beyond one year TCV (Total Contract Value) comes into play.

          TCV (Total Contract Value) is calculated to see total values of multi-year contracts (this could be yearly contracts or subscriptions that have a termination period, but ongoing subscriptions with no defined end are not included). In our previous example your TCV would be $2,250.

          2. There are quite a few ways to spin this and depends how you package your agreements, how granular you want to get and ultimately what works best for you. In my opinion, to simplify, I would associate all fees within a contract as part of the final agreement, given they are a part of the agreement. So, in the examples above you could simply have calculated one-time fees, onboarding fees and training included within the numbers for the same outcome. For example:

          Customer A agrees to a $1000 / year 1 year agreement and pays monthly, which includes onboarding fees.

          Customer B agrees to a $750 / year 2 year agreement and pays yearly, which includes an implementation fee and training fee.

          Customer C agrees to a $500 / year 3 year agreement and pays yearly, which includes onboarding fees and implementation fees.

          At the end of the day this would give you a healthy understanding of your ACV and if you wanted to you could always dig in deeper later.

          To truly calculate ACV more accurately you would want to include Expansion Revenue and Churn.

          ACV = New Customers + Expansion or Existing Customers – Churned Customers. You can read more about this here: http://www.forentrepreneurs.com/saas-metrics-2/

          —————

          Here are the reasons for your confusion. I may be wrong, but I have researched this a lot and trust me there is confusion everywhere within this subject, but these are my conclusions.

          1. ACV vs ACV Bookings – ACV alone is used as an average to understand the average value of your contracts. This is why I look at the following years also. Where as ACV bookings is generally used as a total of your contracts for a 1 year period. When using ACV bookings for a 1 year period you will also see TCV bookings calculated to total multi-year contracts.

          Sometimes ACV and ACV Bookings are used interchangeably, which in my opinion they should not as they are two separate calculations.

          2. Most of the time when calculating ACV people only give an example for 1 customer, which then leads the person to wonder, do I add my customers together or average them to get my calculation?

          3. I may have stated the agreements in a little confusing manner as normally it would be totals not per year. If I would have stated that the agreements were not per year, and instead:

          Customer A was a $1000 agreement for 1 year
          Customer B was a $750 (total not yearly) agreement for 2 years
          Customer C was $500 (total, not yearly) agreement for 3 years

          Then the calculations would calculate differently like this:

          Year 1:

          Customer A: $1000/ 1 year = $1000
          Customer B: $750 / 2 years = $375
          Customer C: $500 / 3 years = $166.67

          Divide by 3 to average them.

          $1000 + $375 + $166.67 / 3

          Year 1 ACV = $1430.56

          Year 2:

          Customer A: Not Included
          Customer B: $750 / 2 years = $375
          Customer C: $500 / 3 years = $166.67

          Divide by 2 to average them.

          $375 + $166.67 / 2

          Year 2 ACV= $270.84

          Year 3:

          Customer A: Not Included
          Customer B: Not Included
          Customer C: $500 / 3 years = $166.67

          Divide by 1 to average.

          $166.67 / 1

          Year 3 ACV= $270.84

          —————

          Here are reference examples of the confusion. I will start with this post.

          Scenario 1 – SaaSMetrics.co

          http://blog.saasmetrics.co/arr-vs-acv-vs-tcv/

          ACV measures the value of the contract over a 12-month period. So let’s say a customer commits to a 24-month contract of $120,000. Considering this money will be recognized as revenue ratably, we’ll have $5,000 in MRR and therefore $60,000 as your ACV.

          It is clear for one contract but this does not specify the outcome of more than one contract so I am not sure if I add or average.

          Scenario 2 – Pipetop.com

          https://pipetop.com/saas-glossary/metrics/acv-annual-contract-value/

          Annual contract value (ACV) is an average annual contract value of your account subscription agreements.

          This is my definition as well.

          Scenario 3 – Zuora.com

          https://www.zuora.com/billing-topics/annual-contract-value/

          Annual contract value (ACV) typically maps to an annualized bookings number. For companies that also charge one-time fees in conjunction with recurring fees, the first-year ACV might be higher than later-year ACVs in a multi-year contract.

          This uses the term annualized bookings and average is not mentioned at all. This leans towards the idea of adding all contracts together vs finding the average value.

          Scenario 4 – Venture Sandbox

          http://www.venturesandbox.com/2013/10/saas-entrepreneurs-show-me-money.html

          ACV Bookings vs TCV Bookings: ACV (Annual Contract Value) counts the expected revenue within the first year, even though some contracts may be multi-year. In order to account for those multi-year contracts we have the TCV (Total Contract Value) metric. We look at both, but care primarily about ACV Bookings.

          This uses the term bookings but then does not use the term bookings within the definition. It also doesn’t specify how to calculate ACV (or ACV Bookings) with more than one customer. It leaves you asking, should I add or average?

          Scenario 5 – SaaS Optics

          http://www.saasoptics.com/saaspedia/saas_bookings

          SaaS Bookings – Broadly speaking, bookings refers to the total value of accepted term contracts, contracted work or services, and changes to such contracts as of either the order date or the effective date of the transaction.

          This simply is used to back up the fact that bookings is used to define total value and not average value. So when adding Bookings to ACV Bookings it would be a total value of first year vs average. Even more confusing is how sometimes bookings may not total multiple years but count them as renewals instead. Either-way though this would total first year value of contracts.

          —————

          I didn’t go into this planning on breaking this down quite so much, but as I dug further I found so many discrepancies that I started second guessing things and breaking this down for myself as well.

          If you get anything out of this, I hope you have a clear way to calculate ACV and ARR for your company and most importantly it is consistent and the same way you and the rest of your team agree to calculate and measure it.

  • Julie Willey

    Hi Leo,
    Thanks for this. I have a few clarifications on ACV. In the example you mention a multiyear agreement. What if the the multiyear agreement has escalating annual amounts? Would you average over the life? If no, how would ACV “account” for the years after Year 1.

  • Todd Crick

    Our company is transition from selling perpetual licenses to SaaS so we are redesigning our metrics. One of the biggest transitions is from TCV to ACV.

    We’ve done our homework and the Blog here is very helpful. But we are stuck on one thing.

    Our renewal team (for both our perpetual business and the new SaaS business) usually renew customers early, 3-6 months early.

    So, if we close a one year renewal deal with the customer on June 1 and the renewal is effective on September, it will book for TCV on June 1. But how do we treat the booking for ACV? There are 3 ways we’ve discussed.

    1. Book 9/12 of TCV on June 1. The other 3/12 is never booked.
    2. Book 9/12 of TCV on June 1 and 3/12 of TCV on June of the next year.
    3. Book TCV on June 1 and ACV (same amount) on September 1.

    Any advice from anyone would be appreciated.