What is LTV to CAC Ratio?
By Lior Ronen | Founder, Finro Financial Consulting
The LTV (or CLV) and CAC are two critical KPIs. When combined, they're even more powerful.
The customer lifetime value (LTV or CLV) measures the value of customers over time.
It calculates how much loyal customers are worth to the business over the entire period of using its products or services.
The customer acquisition cost (CAC) measures how much a business spends (or invest) to acquire one new client.
When LTV and CAC are combined, we get a powerful ratio that tells us whether we generate enough revenue from each client to justify the cost of acquiring this client.
What is enough?
The rule of thumb is that the LTV should be at least 3x than the CAC, which means a customer should generate three times more revenues than in cost to acquire this customer in the first place.
Otherwise, it just doesn't worth it.
How to Calculate the LTV to CAC Ratio?
First, let’s start by calculating a startup’s CAC.
It's pretty simple. You divide the annual or monthly sales and marketing spend (including both payroll and non-payroll expenses) by the number of new customers you added in that specific period.
Let's look at an annual CAC, for example.
if you spent last year $100k on the payroll for sales and marketing, $50k on paid ads, and acquired 1,500 new clients, your annual CAC for that year is:
($100,000 + $50,000) / 1,500 = $100
Second, we’re moving on to calculate the LTV.
The most common and straightforward customer lifetime value calculation uses the Average Revenue Per User (ARPU) and the customer lifespan or the churn rate.
For the LTV or CLV calculation, we need to multiply the ARPU with the customer lifespan. Make sure that both items use the same time units. If you're using a monthly ARPU, use the customer lifetime in months, but use the customer time value in years if you're using an annual ARPU.
For example: if the ARPU of a particular business is $20 per month and the average customer lifespan is four years, so the LTV is $20 x 48 = $960.p
Third, let’s put the two figures together. The LTV to CAC ratio is $960 (the LTV) divided by $100 (The CAC) = 9.6x
What Does The LTV to CAC Ratio Mean?
That client generates $960 in revenues to the company when onboard, while the company spent $100 to acquire this client. So the LTV to CAC ratio is 9.6x, higher than the rule-of-thumb of the optimal 3x LTV to CAC ratio.
It means that the revenue a company generates from a single customer over its lifetime is worth the cost of acquiring this client.