LTV/CAC Ratio, or Lifetime Value to Customer Acquisition Cost Ratio, measures the ratio of the amount of revenue a customer will generate over the entire duration of their subscription to their acquisition cost. LTV/CAC is a composite metric that combines LTV and CAC to measure efficiency and profitability in acquiring customers. LTV measures the lifetime profitability of a customer, and CAC measures the customer’s acquisition cost. LTV/CAC thus measures how many dollars of customer lifetime value are returned for every dollar spent on customer acquisition. Let’s look at each component of LTV/CAC below:

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How do I calculate LTV?

While there are several kinds of LTV calculations, SaaSGrid uses Simple LTV to calculate LTV/CAC. Simple LTV is an approximation of customer lifetime value (CLTV) using annual contract value, gross margin, and churn rates. Simple LTV is calculated with the following formula:

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• Annual Contract Value is the average annualized contract value of all customers
  

• Gross Margin is the percentage of revenue that remains after subtracting COGS
  

• Churn Rate is the percentage of customers that churn after some period of time

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For example, with an ACV of $21,000, a gross margin of 40%, and a churn rate of 13%, Simple LTV is equal to ($21,000*40%)/13%, or $64,615. This can be interpreted as the average lifetime value that a customer will have. Note that to calculate a trailing simple LTV, Gross Margin and Churn Rate must have the same trailing period.

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How do I calculate CAC?

CAC (Customer Acquisition Cost) represents the sales and marketing cost of acquiring a new customer. CAC can be represented with the following formula:

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To account for sales cycle length, new customers in a period are compared to sales and marketing expenses from a previous period. This offset is typically 1-3 months, but can vary depending on the metric and the date aggregation, and more correctly ties S&M costs to their resulting revenue.
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For example, if S&M expenses in April were $500,000 and there were 20 new customers in May, then the CAC (1-month offset) would be $25,000.

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How do I calculate LTV/CAC?

Combining the formulas above, LTV/CAC can be represented as:

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With five different metrics in the formula, it can be helpful to explore the different effects of these metrics on overall LTV/CAC:

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Let’s bring together the two metrics above to calculate LTV/CAC:

We’ve calculated LTV to be $64,615 and CAC to be $25,000. We can then calculate LTV/CAC as $64,615/$25,000, or about 2.6. We can also write LTV/CAC as a ratio: here, the LTV/CAC can be represented as 2.6:1. This indicates that the business returns $2.60 for every dollar spent acquiring a customer.

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How should I interpret LTV/CAC?

LTV/CAC can be a powerful signal to indicate inefficiency, high costs, or poor retention. A healthy LTV/CAC ratio is ideally 3:1, with $3 in revenue coming in for every $1 of acquisition costs. To increase the  LTV/CAC ratio, businesses can either increase lifetime value or reduce acquisition costs. Other LTV/CAC ratios can be interpreted as follows:

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SaaSGrid allows you to explore your LTV/CAC and turn your data into insights. Talk to us here to learn more!