What is Total Contract Value (TCV)?

A contract’s overall financial worth over its term is gauged by its total contract value or TCV. It stands for the total amount of money that a project under contract is anticipated to bring in throughout the agreement, including both ongoing and one-time fees. Determining the total value of your contracts contributes to more accurate financial forecasting, planning, and evaluation of your company’s profitability. 

Total Contract Value (TCV) is a crucial measure for SaaS companies. This is how to figure it out: 

TCV Formula:

TCV = (Monthly Recurring Revenue * Contract Term Length) + One-time Fees

 Let’s dissect the elements:

Monthly Recurring Revenue (MRR): This is the predictable, recurring revenue you receive from a customer each month. It’s the foundation of your SaaS business model.  

Contract Term Length: The time the customer is committed to your service, typically expressed in months.  

One-time Fees: These are any non-recurring charges included in the contract, such as implementation fees, onboarding fees, or training fees.

Though their applications and scopes are different, Total Contract Value (TCV) and Annual Contract Value (ACV) are both essential measures for comprehending money derived from customer contracts. Businesses, especially those using SaaS and subscription-based models, must comprehend the differences between these metrics in order to evaluate contract value, forecast revenue, and make wise business decisions.

• TCV offers a thorough analysis of the entire contract value over the course of the agreement, taking into account both one-time and recurring payments. This comprehensive approach assists companies in determining the actual financial value of a contract and in making well-informed choices regarding pricing and client acquisition. 
• ACV provides insights into growth, revenue forecasting, and client group comparisons by focusing on the annual recurring revenue generated by contracts. This enables companies to monitor their development, spot patterns, and modify their marketing and sales plans.
• While TCV is frequently used as a revenue metric, it may not accurately reflect the true annual revenue, especially in contracts with short terms or high upfront costs.
• One-time payments and possible upsells are not factored into ACV. This may lead to an underestimation of the overall value of a contract. 

To get a whole view, businesses must take into account both measures.

Although TCV can be a useful indicator for assessing a contract’s prospective worth, it’s critical to understand its limitations. 

• Revenue recognition timing is a factor to consider when evaluating TCV. Although a contract’s revenue may be distributed over a number of years, TCV counts the contract’s full value at the year of signing. 
• It is important to acknowledge that TCV does not strictly adhere to the revenue recognition principle, which may necessitate additional considerations when evaluating financial performance. Revenue should only be recorded when it is earned and realized, according to this principle. TCV might presume that a contract’s full value would be realized, although this isn’t always the case.  

Example: 

The TCV for a $1 million software services contract, for instance, would be $1 million if a customer signed it. However, the actual revenue recognized in the first year would only be $500,000 if the customer only paid $500,000 of that amount. These restrictions should be taken into account when using TCV as a metric. 

Other indicators like ARR, MRR, LTV, CAC, and churn rate should also be examined in order to obtain a more complete view of a company’s performance.

Knowing TCV is essential for determining your top clients, accurately forecasting future revenue, and assessing overall performance. 

• TCV has a big influence on financial health evaluations and strategic planning. Businesses may analyze contracts to understand the potential financial impact on future growth, which can then guide strategic decisions. 

• Because it allows companies to evaluate the yearly worth of each customer contract and determine the effectiveness of their acquisition efforts, TCV is an essential part of customer acquisition and retention strategy. 

• TCV provides insights into customer interactions, influencing their revenue stream, and potentially affecting budgeting decisions. 

• By analyzing pricing strategies, companies can gain insights into how to optimize profits and target specific customer groups.

TCV is a useful metric, but it’s crucial to keep in mind that it only shows contracted value and not always actual income. Unexpected changes in the market, pressure from competitors, and difficulties with execution might affect a company’s capacity to reach its full potential. To guarantee precise forecasting and informed decision-making, companies should thus routinely track and evaluate their TCV performance in addition to other important metrics.