Read TL;DR
- The LTV:CAC ratio is a vital metric for evaluating the performance of SaaS businesses. It measures the efficiency of acquiring customers and compares it to the value they bring over their lifetime. Click here to learn how it's calculated.
- By analyzing LTV:CAC ratio, SaaS companies can evaluate unit economics, assess growth potential, and set strategic goals for customer acquisition and retention.
- A high LTV:CAC ratio indicates higher growth potential, while a very high ratio indicates missed opportunities due to limited sales and marketing expenses. A low ratio indicates inefficiency in customer acquisition and lowers your company's valuation.
- Find a good LTV:CAC ratio by analyzing the percentage of your operating costs spent on sales and marketing. Divide 1 by that number for your benchmark.
Table of Contents
Why is the LTV:CAC ratio important?
The LTV:CAC ratio is important because it helps you bring context to your CAC. While CAC is useful information by itself, comparing it with your LTV lends additional value as it helps to evaluate performance.
LTV:CAC ratios reflect your growth and revenue potential, which depend not only on acquiring new customers but also keeping the customers you have for as long as possible. The ratio is a true reflection of your unit economics. While CAC is an effective measure of your sales and marketing team’s efficiency in acquiring new customers, it doesn’t tell you the value of those customers to your business. This is what your LTV tells you. LTV is influenced more by your customer success and product teams. So, comparing the two metrics can give you deeper insight into your business.
Using the LTV:CAC ratio to set clear department goals will help you delight more customers, foster more sustainable growth, and increase your profitability.
Learn more about SaaS metrics here
How to calculate LTV:CAC?
In this equation:
- LTV is the average recurring revenue (adjusted for churn and gross margin) that your customers generate over the life of their accounts, subscriptions, or contracts.
- CAC (at the customer unit economic level) is the average sales and marketing cost (including overhead and salaries) required to acquire a new customer. You can calculate CAC based on ARR (also known as CAC Ratio) by dividing sales and marketing expenses by the new ARR acquired in that period.
The following example illustrates how to calculate a simplified LTV:CAC ratio:
You can calculate your LTV CAC ratio depending on how you calculate LTV and CAC. Here’s an example calculation of LTV CAC ratio at the customer unit economic level.
Note that you can calculate the LTV CAC for any period. Our formula above illustrates a monthly period. You can calculate an annual version by substituting monthly revenue with annual revenue (and according for churn and other variables.)
Use numbers recorded within the same period. For instance, do not combine last month’s revenue with another month’s churn, sales and marketing costs, and new customers acquired.
Let’s look at an example calculation of the LTV:CAC for the last 12 months (LTM) for Company A based on the following expenses and customers acquired:
- Average monthly recurring revenue per customer = $100
- Gross margin = 80%
- Monthly churn rate = 10%
- Monthly sales and marketing spend = $12,000
- New customers acquired this month = 15
There are three steps to the calculating the LTV:CAC ratio at the customer unit economic level:
You can calculate your LTV:CAC ratio based on revenue too, depending on how you calculate CAC. In the previous example, we calculated CAC per customer acquired. However, you can calculate CAC per dollar of revenue earned too:
As with the previous formula, use numbers from the same period without phase shifts. You can adjust for annual periods by substituting annual for monthly numbers.
Note that this formula accounts for subscription revenue only. If you wish to account for services revenue, the LTV component is:
The formula above works well for SaaS companies since it is operationally simple to calculate. You don’t have to use discounted cash flow (DCF) models with growth and discount rate assumptions. Neither do you have to estimate adjusted margins.
Now, let’s look at how we would calculate Company A's subscription LTV:CAC based on its revenue:
- Average monthly recurring revenue per customer = $100
- Gross margin = 80%
- Monthly churn rate = 10%
- Monthly sales and marketing spend = $12,000
- New MRR acquired this month = $1,500
There are three steps to the calculating the LTV:CAC ratio at the customer unit economic level:
Using the same data for Here’s a three-step example calculation that considers just subscription LTV:CAC based on revenue generated.
Can LTV:CAC be too high?
Evaluating your LTV:CAC shows how efficiently you’re using company resources to acquire customers and generate revenue from them. It plays an important role in your KPI-based SaaS financial planning efforts.
Before we dive into benchmarks, here’s what you need to know about high versus low LTV:CAC values:
- If your ratio is high (value exceeds costs) – This signals efficiency in your customer attraction and retention. It’s also a sign of your company’s potential for fast growth with minimal outside investment (a plus for attracting new capital). However, too high a ratio suggests missed opportunities for speedier customer acquisition – something you can address by investing more in sales and marketing.
- If your ratio is low (costs exceed value) – This signals inefficiency in acquiring new customers. The likelihood of requiring additional capital can lower your company’s valuation (a drawback for investors). However, too low a ratio may simply indicate a newer business with a shorter customer lifespan and higher initial marketing spend.
So, what is a good LTV:CAC ratio for SaaS?
There is no single good LTV:CAC ratio number since it depends on the state of your business.
A good approach rule of thumb for figuring out what a good LTV:CAC ratio is for your company is to first analyze your overall operating costs to determine what percentage is attributable to sales and marketing costs. Then just divide one by that number to get a benchmark for your business. The result represents the minimum LTV:CAC you need to achieve to break even. Anything greater than this ensures you’re making money. Anything less than this means you’re not making enough from your customers to cover your operating expenses, and you will have to source funds through equity or debt financing.
Let’s look at a couple of examples. Company A has the following expenses:
- Sales and marketing costs (S&M) = $800,000
- Research and development costs (R&D) = $400,000
- General and administrative costs (G&A) = $200,000
- Total operating expenses = $1.4M
Company A’s S&M costs are 57% of total operating costs. So, it needs an LTV:CAC of 1.75 (1 divided by 0.57) to break even.
Now, let’s look at Company B with the following expenses:
- S&M costs = $800,000
- R&D costs = $800,000
- G&A costs = $1,200,000
- Total operating expenses = $2.8M
For Company B, sales and marketing costs are 28% of its total operating costs. With its operating expenses, it needs an LTV:CAC of at least 3.57:1 (1 divided by 0.28) just to break even.
Benchmarking your data using this rule of thumb is an effective way to gauge sales efficiency and growth. However, for a more complete picture of your company’s health, you should combine the LTV:CAC ratio with other information and metrics.
For example:
- To assess how strategies are being executed across departments, you should weigh LTV:CAC efficiency alongside expenses like product development costs.
- To fully evaluate the significance of a low (1:1) ratio, you should take your growth stage, sales process development, and metrics like the sales-to-working capital ratio into account to lend more context to your analysis.
- To protect your financial foundation, you should pair the soaring revenues indicated by a high (5:1) ratio with regular audits of your operating expenses and budget.
Analyzing and monitoring LTV:CAC results is simple with Drivetrain?
By bringing your financial and business applications together on a single platform, Drivetrain lets you:
- Access and track key SaaS metrics like LTV and CAC in one place.
- Create actionable dashboards to analyze and forecast metric trends with minimal effort.
- Create board-ready reports that narrate the story behind your LTV:CAC numbers.
- Evaluate LTV:CAC across different dimensions in your business such as market segment and product lines.
Build data-driven financial models, monitor your goal progress, and adjust plans to stay on target for improving LTV:CAC outcomes with Drivetrain.
Taking advantage of the LTV:CAC ratio is essential for making informed sales, customer, and hiring decisions. Managing SaaS growth can be challenging. The better you understand your numbers, however, recurring revenue and investors your company stands to attract.
FAQs
The LTV:CAC ratio compares the average revenue you generate from your customers with the sales and marketing pend required to bring them in. It does this by comparing two important SaaS metrics, the customer lifetime value (LTV) against the customer acquisition cost (CAC).
The simplest way for SaaS companies to calculate the LTV:CAC ratio is by using the following formula:
LTV:CAC = (average monthly revenue per customer * customer lifetime in months) ÷ (total sales and marketing costs ÷ number of new customers acquired)
There is no single good LTV:CAC ratio number since it depends on the state of your business. To calculate a good LTV:CAC ratio for your company, figure out what percentage of operating costs your sales and marketing expenses are. Divide that number by one.
This is the minimum LTV:CAC you need to achieve to breakeven. Anything greater than this ensures you’re making money.
Anything less than this means our customers are not funding operations and you will have to source funds through equity or debt financing.
