LTV:CAC Ratio

LTV:CAC ratio stands for customer lifetime value (LTV) divided by customer acquisition cost (CAC). The formula compares the cost to acquire a customer with how much gross profit the customer provides your business over their lifetime as a customer. 

LTV:CAC ratio is a common measurement for SaaS companies because it provides insight into the sustainability of a business model. It answers the question, are we spending too much to acquire customers compared with what we get in return?  

Below, I’ll answer the following questions:  

• What is LTV:CAC ratio?
• Why does LTV:CAC ratio matter?
• How to calculate LTV:CAC ratio
• What is a good LTV:CAC ratio?

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Why does LTV:CAC ratio matter?

The LTV CAC ratio is one of the most important metrics for SaaS companies. 

It's a simple equation that takes into account your customer lifetime value (LTV) and compares it to your customer acquisition cost (CAC). 

This can be a useful way of determining whether you're investing too much money in acquiring customers: if the number is below 1, you're losing money; if it's above 3, you are making money; and if it's exactly 1 or 2, then there isn't much margin for error when marketing campaigns fail.

Startups should monitor their LTV:CAC ratio and strive to keep it above 3:1. That tends to be the general rule of thumb. 

As you introduce new customer acquisition channels, monitor your LTV:CAC ratio for each new channel. This will be an imperfect science because there’s no such thing as perfect marketing channel attribution, but you can get close if you set up your marketing campaigns properly. 

How to calculate LTV:CAC Ratio

The LTV:CAC ratio formula is simple to calculate. Start with the formula for your Customer Lifetime Value (LTV) and your formula for Customer Acquisition Cost (CAC). Then divide LTV by CAC. That’s it. 

See an example below: 

LTV = $ Average Revenue Per User (ARPU) * % Gross Margin / % Customer Churn

CAC = (Total Marketing Expenses + Total Sales Expenses) / Total Number of New Customers Acquired During the Period   

LTV:CAC Ratio = LTV / CAC

What is a good LTV:CAC ratio?

Typically, the ideal LTV:CAC ratio for a healthy business is three-to-one. 

That means that if you sell $100 of product, you can only spend $33 in customer acquisition costs to be profitable. 

If your LTV:CAC ratio is lower than 3:1, it may mean that either your marketing campaigns are too expensive, your headcount costs are too high, your margins are too low, your customer retention is poor, or something else.

Use the Sales Forecast and Marketing Budget Template to calculate your historical CAC:LTV ratio and forecast how it will change as you execute initiatives to drive revenue growth.