As much as we’d all like a Magic 8-Ball that can tell us the best sales strategy to use for every client, companies need to rely on numbers instead. While metrics can’t predict the future, they’re the best way to inform companies of what their next steps should be.
One of the most useful sales metrics is ACV. It often goes under the radar, but it’s a crucial measurement that helps businesses decide where to direct their focus at any given time.
You may have seen this acronym floating around the sales sphere and wondered, What does ACV stand for in sales? ACV is short for annual contract value, and in this article, we’ll discuss why it’s important and what makes it different from other key metrics. We’ll also provide some examples of calculating ACV using hypothetical case studies.
But first, let’s start with the essentials—what is ACV in sales?
The ACV sales metric enables businesses to track the value of individual customer contracts over a year. Basically, it’s the average annual dollar amount a contract is worth, excluding any one-time fees or purchases.
ACV measures the value of a client from a single fiscal year by accounting for:
- Monthly contracts
- Annual subscriptions
- Consulting services
It also includes the yearly value of a multi-year contract. By adding up the worth of all these details, companies can estimate how much recurring revenue a client brings to the table. The metric helps companies understand the value of each client and provides them with a plan for growth going forward.
Importance of knowing ACV in sales
At this point, you may be asking yourself: Why is it important to know the value of one contract? While it’s true that these sales calculations are less useful for large-scale budget planning, there are three essential uses for ACV in sales.
Measuring sales rep performance
By looking at every account’s ACV and matching it to the salesperson who secured the sale, you can calculate how much annual revenue that rep generated. While this metric isn’t the only way to gauge a salesperson’s performance, you can use it in conjunction with other key performance indicators (KPIs) to track accomplishments.
In this sense, ACV can help companies develop onboarding strategies for new sales reps, improve their training programs, and determine the ROI of their current hiring practices.
Learning which accounts to prioritize for sales reps
With ACV, sales reps can see the annual income they’re bringing in. They can also learn which clients to target with customer success strategies throughout the year. With the help of sales analytics, they can identify ways to retain their high-value clients once those contracts approach their end date. That way, when a client is nearing the end of their contract, sales reps can use CRM software to develop strategies for:
- Discussing an extension of their contract
- Potentially upselling and cross-selling products
- Gathering customer feedback
- Presenting discounts or promotions to encourage a contract renewal
Learning which accounts to prioritize for executives
Unfortunately, every company has limited resources when it comes to managing client relationships. Even with the help of contact management software, customer service and success teams often have to manage a variety of accounts every day. This means some clients are inevitably left waiting in line.
When companies need to spread out their resources, it’s crucial to know which clients bring in the most recurring revenue. By looking at ACV sales reports, businesses can see the value of each account and task their staff with focusing on the highest-value clients.
For example, imagine a company looks at its sales dashboard and determines the highest ACV for an account is Client A with $30,000, and the lowest is Client B with $15,000. Client A holds more value for the business than Client B, so the company would be wise to allocate more resources to Client A to ensure their needs are met with greater urgency.
Now that we understand how useful ACV can be for companies, let’s learn how to calculate this metric.
Annual contract value calculation
As we’ve mentioned, ACV is a dollar amount, which means it’s time to break out the calculator. Most CRMs for small businesses include lead management functionality and SFA features that will calculate ACV for you. But you can use a simple equation to figure it out manually if you have the right data.
The total value of all contracts includes any recurring fees on a monthly or yearly basis as well as the buy-in for a multi-year contract. Next, let’s look at how this calculation pans out using an example scenario.
ACV example for sales
Let’s say Client A signs on for a five-year subscription plan with a total value of $15,000. To calculate ACV, plug these numbers into the equation above.
Annual contract revenue = $15,000 ÷ 5 = $3,000
So, the yearly value of this company’s contract would be $3,000. However, the calculation isn’t always this straightforward.
Say Client B also signs on for a subscription plan, but they only need a four-year subscription with a value of $12,000. They would also like to add a four-year agreement to a monthly subscription, which costs $100 a month.
First, we’ll find the total value for the monthly subscription service over four years:
$100 x 48 months = $4,800 in four years
Then, we can add this to the total value of the original contract.
$12,000 + $4,800 = $16,800
Finally, we’ll divide the total contract value by the number of years to find the recurring revenue for each year:
$16,800 ÷ 4 years = $4,200
In this case, the annual value of the contract is $4,200 over four years.
By calculating ACV manually (or with the help of a strong sales app), companies can find a close estimate of how much money they’ll receive from a single source in one year. But if a company wants to find its overall annual revenue, that’s a different metric entirely.
ACV vs. ARR
Annual recurring revenue (ARR) is a metric that shows the amount of money a business makes from subscriptions or contracts over one year.
The main difference between ARR and ACV sales metrics is where you focus your measurements. With annual contract value, you’re looking at only one account to determine how much average recurring revenue is gained from that specific source. Meanwhile, annual recurring revenue shows the total dollar amount accumulated from every recurring contract in 12 months. MRR—or monthly recurring revenue—breaks down the time frame to months instead of a single year.
There are also differences in what types of contracts you can measure. ARR is only effective when calculated with contracts lasting a year or longer. If a client agrees to an eight-month plan, you wouldn’t want to apply that revenue to your annual measurement, as that would produce an inaccurate tally.
Such limitations make annual recurring revenue less useful as a measurement of individual performance. But ARR is a more accurate method for measuring yearly revenue, so it’s a great way to track revenue growth.
To highlight the differences between these two metrics, let’s see what an ARR calculation might look like.
Most sales force automation systems can make these calculations for you, but it’s still good to know the annual recurring revenue formula:
This equation calculates a company’s total yearly revenue gains, minus what they lost due to clients churning or downgrading their subscriptions.
Imagine in a single year, a company secures 20 new clients, each with a subscription value of $2,000. That generates a total value of $40,000. However, the company also loses five client subscriptions, leading to a total loss of $10,000.
In the same year, 10 clients upgrade their subscriptions to a $2,500 subscription, for an overall value increase of $5,000. Meanwhile, four clients decide to downgrade to a $1,500 subscription, for a net loss of $2,000.
This company also brings in $200,000 each year with its current monthly subscription plans.
Let’s put that all together in the ARR equation:
ARR = ($200,000 + $40,000 + $5,000) – $2,000 – $10,000 = $233,000
ACV helps companies keep their priorities in order
ACV is a key tool for growth, especially for businesses that rely on subscription sales rather than one-time purchases. It’s also a great metric for helping you prioritize your sales efforts and resources. Of course, every customer is important in business. But ACV sales calculations enable you to pinpoint exactly who is providing the most value to your company, so you can strategize ways to acquire similar accounts in the future.