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Answering a common question for business owners
LTV:CAC ratio is one of the most important metrics for businesses in the software and eCommerce space.
The ratio is used as a way to gauge how efficiently your marketing operations are functioning. It’s also used to plan future marketing spend/budget. The LTV:CaC ratio is a metric that finance teams need to understand in order to effectively work with marketing teams.
Lets break down how to calculate each metric.
Lifetime Value (LTV)
LTV (sometimes known as CLV) is basically the average value of an acquired customer. There’s a few different ways we can calculate LTV but at a high level it’s just how valuable an acquired customer is.
LTV can be calculated in the following ways:
- Total Revenue over a period of time / # of customers over a period of time
- Gross Revenue over a period of time / # of customers over a period of time
- Net Revenue over a period of time / # of customers over a period of time
Gross and Net Revenue are more conservative calculations of the value of a customer as you’re subtracting Cost of Goods Sold expenses and below the line expenses such as warehouse costs or staffing costs.
The “period of time” is an important criteria especially for finance purposes. For subscription businesses that charge a monthly fee this is typically easier to predict. Lets say you have a B2B SaaS finance platform that provides users an immense amount of value like Kordis. Our lowest pricing tier is $100 a month. Even though our product is amazing, the reality is that a % of our users will churn (cancel their subscription). And more users will churn as time goes on which is why the period of time you’re looking at is important. See the below example.
You’ll see that in month 6 we’re at about 250 users whereas in month 3 we’re at 500. So the Total LTV of my users over the first 3 month period if $210.
LTV 3 months = Revenue From First 3 Months/1000(Customers from Mo 1)
But if I look at it over a 6 month period the number goes up to an LTV of $308 after I add in the revenue from months 4-6.
The time horizon you choose to look at ultimately depends on your cash runway. If you somehow have a boatload of cash sitting on your balance sheet and you want to aggressively pursue growth, you can look at a longer time horizon like 12 months. However if you’re a bootstrapped startup you need to calculate your optimal payback period or the time to get back your initial investment to acquire these customers. This is why its important for CFOs and finance departments to work hand in hand with marketing teams in defining items like the payback period and cash runway. Our fractional CFOs at Kordis have years of experience working with marketing teams and founders to give them the right information to best optimize their strategy and tactics.
Now if you’re a newer business you may be asking well I’m not sure how many customers I’ll keep (retention rate) because I don’t have a lot of data to be confident about. This is a scenario that many businesses run into (even established ones). The fact of the matter is that you’ll need to look at industry benchmarks and conservatively estimate what you might expect to see. Here is a good starting point to find that information.
Last part which is something I alluded to earlier is that calculating your LTV is much easier in a subscription business. For non-subscription businesses you need to do a cohort analysis and pull in repeat purchase rates to calculate your LTV.
Customer Acquisition Cost (CaC)
CaC is more straight forward than LTV. Its just the amount of money you spent acquiring the customers divided by the number of acquired customers
So in the aforementioned example we acquired 1000 customers in the first month. Lets say we spent an even $10K to acquire those customers. Our CaC is going to be $10.
$CaC = Dollars Spent/Acquired Customers
Typically Dollars Spent is your paid media dollars. So basically any money spent to advertise on Meta, Google, or even a billboard. Generally its easier to track CaC for digital platforms due to tracking pixels. Tracking offline marketing/advertising can be difficult and is a long discussion for another day.
The other component you can include in CaC is your production costs for the advertising. For example if you’re running Meta ads and are paying an agency $1000 a month for video content you can include that number to get to a more accurate CaC number.
LTV to CaC Ratio
Now that we’re clear on how to calculate LTV and CaC, whats a good LTV to CaC ratio?
Typically a ratio anywhere between 3:1 and 4:1 is where you want to be. If you’re looking to be more aggressive about growth and maybe just got a round of investor funding, you can push the ratio below 3:1. However, if you’re going to be more aggressive about growth we recommend working with a finance professional to make sure you don’t end up like the hundreds of companies who aggressively pursued growth during the zero interest rate era.
The reason 3:1—4:1 is a comfortable zone for businesses is that typically this ratio will cover not only the acquisition costs but other costs of the business such as COGs, Wages & Benefits and more. To put it simply you can be easily profitable over the long run at this ratio.
There’s also the case where your LTV to CaC ratio is higher at 7:1 or 8:1. This is typically a good problem to have but nonetheless a problem. At this ratio you’re actually not spending enough on acquisition and marketing and should probably be investing more of your profits to capture more of your target market.
What’s right for your business?
As always it depends. We’ve given you some general guidelines on how to calculate the LTV:CaC ratio and some high level benchmarks to aim for.
If you really would like to understand a good ratio for your business our fractional CFO team can be of help. With over 50+ years of combined experience working in the world of finance, they are equipped with the knowledge to help your business scale growth profitably. Schedule an intro call today.