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Why You Need To Measure Your CAC To LTV Ratio

The CAC to LTV ratio of your business is a vital metric, as it crystallises exactly what level of return you can expect for the money spent on marketing and customer acquisition. It can be used to inform decisions in the future, such as increasing the spend on advertising or finding new ways of maximising the value which each customer represents. 

Breaking down the CAC to LTV ratio

In simple terms, the CAC to LTV ratio consists of two different figures and the impact the first might be having on the second. The first of these is the CAC, which is the Customer Acquisition Cost. This refers to the amount spent on acquiring each new customer, and it is calculated by taking the full amount of money spent on acquiring new customers per se – on aspects such as marketing, advertising and optimising your online presence – and dividing that amount by the number of new customers acquired.

An example of a CAC calculation

Over a single quarter your business invested £20,000 in measures designed solely to acquire new customers. During the same period the business actually acquired 4,000 new customers. This means that the CAC is £20,000 divided by 4,000, which equals £5.

When calculating the CAC of your business it is vital that you abide by two guiding principles:

  • Don’t count the cost of retaining existing customers (loyalty bonuses etc.). The CAC will only be an accurate measure if it applies solely to new customers being brought on board.

  • Include the widest possible range of expenses above and beyond marketing. From the salaries paid to the marketing team to the costs generated by any onboarding process, everything has to be included if it is a genuine expense generated while acquiring new customers.   

The importance of the CAC 

Knowing the CAC of your business is vitally important. It can be all too easy to lose track of multiple marketing channels, but calculating the CAC brings all of the spending together in one place. This is particularly useful for subscription-based businesses such as SaaS, which is driven by recurring revenue. If the CAC is too high, then it will take a prohibitively long time for your business to earn it back. The CAC is only useful if it’s considered in terms of the revenue each customer brings in, and this is where the CAC to LTV ratio comes into its own.

What is LTV?

LTV stands for the Lifetime Value of a customer, and it represents the amount any given person will spend with you during the duration of their time as a customer. For a SaaS business which is based around a model of long-term recurring subscriptions, a high LTV is the key to success.   

Calculating the LTV of one customer can be tricky, as it will rely on predicting exactly how long that customer will stay with you. The simplest way of arriving at LTV is to take the monthly recurring revenue of multiple customers and divide that figure by the overall number of customers, reaching an average revenue per user (ARPU). This figure then has to be multiplied by the average number of months each customer spends with you; a number which can be extrapolated from the monthly user churn.   

What is a good LTV to CAC ratio?

Once you’ve calculated the CAC and LTV you can calculate the LTV:CAC ratio, which highlights how much profit each new customer is driving. A ratio of 3:1 is ideal, with each customer bringing in 3 times the amount spent on acquiring them.

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