TCV & ACV - Lets Talk About Revenue and the Importance of Backlog
Buyers may discount the quality of your revenues because of the way you characterize them. Take steps to avoid the wrong conclusions that will ultimately undermine your valuation.
A constructive discussion with buyers about your revenues starts with some common terminology. Unless your terms mean the same, discussions can become confused or worse, misunderstandings develop and your revenues may get undervalued. The picture can get confused when the revenue model of the buyer and seller differ and the traditional license model collides with the subscription model. This disconnect can permeate all aspects of the discussion from revenue metrics, forecasting, sales quotas, pipeline management, invoicing and revenue recognition. Here are some simple definitions for common terms in the revenue discussion that will help.
Total Contract Value (TCV) the total value of a customer contract. TCV includes one time and recurring revenue, but only the recurring revenue for the period specified in the contract.
Annual Contract Value (ACV) the recurring value of a customer contract over any 12 month period. ACV excludes one time revenues.
Revenue the portion of TCV which has been recognized as income on the Income Statement according to GAAP.
Backlog the portion of TCV that has not yet been recognized as revenue but will when the product is delivered or the services performed. The total value of the backlog is typically not represented on the balance sheet.
Life-To-Date (LTD) - the total amount of revenue generated over the duration of a customer relationship. In this context, LTD often spans multiple contracts with the same customer. The context can also be narrowed to a specific contract for an array of products and/or services over an extended period of time.
Bookings a sales term for the total value of the customer contract (TCV) at the time the deal closes. The term refers to new sales only, as in new sales (bookings) closed this month.
Invoice the amount specified on an invoice or group of invoices generated over a period of time. In many subscription software businesses, invoiced amounts for recurring revenue will equal ACV since the business typically invoices these amounts for 12 month periods.
Beneath this discussion is something even more important than terminology. Your choice of terminology reveals how you, the business leader, think about revenue, the maturity of your concepts and the relevance of your metrics for managing revenue. The most overlooked and misunderstood concept in this list is backlog.
Many companies don't appreciate the value of tracking backlog closely or reporting it clearly. The difference between your revenue target and your backlog indicates the amount of revenue from new sales that you need to generate. Because revenue in backlog is essentially locked-in, it is a good leading indicator of your business performance and reflects the amount of the risk in your revenue forecast. It should also affect how you set sales quotas and structure sales commissions. In businesses with a high proportion of recurring revenues (subscription and maintenance) or services revenues, this metric is critical.
A comprehensive understanding of the backlog sends the right messages about your financial management of the business. Portraying backlog in accurate detail supports significantly stronger valuations.