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. Note that churn rate is annualized in the formula, as it is compared to Annual Contract Value, which is an annualized figure.

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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!