July 13, 2021
6 Min Read
Your LTV:CAC ratio helps you understand if your marketing efforts are leading to profitability.
If your LTV:CAC is too low, you’re spending too much. If it’s too high, you could be leaving opportunities on the table. Using that knowledge, you can make smarter decisions about your marketing investments and find ways to make your business more profitable.
In this article, we’ll walk you through what the LTV:CAC ratio is, how to calculate it, how to use it, and the mistakes you need to avoid when calculating it.
By the end, you’ll be ready to start analysing your marketing campaigns in more detail. With LTV:CAC, you can discover which channels are performing best, identify the customer segments generating the most revenue, and improve your overall business profitability.
LTV:CAC shows you the difference between your Customer Acquisition Costs (CAC) and Customer Lifetime Value (LTV).
Knowing your LTV:CAC ratio tells you whether or not the customers you’re acquiring are worth more to your business than the amount it costs you to acquire them.
Ultimately, this helps you understand if your marketing efforts are working and if your customers are bringing enough revenue to cover your marketing costs.
To calculate your LTV:CAC, you’ll first need to know both your customer lifetime value and your average customer acquisition cost.
The formula for customer lifetime value (LTV) is:
Average Revenue per Customer * Average Customer Lifespan = LTV
You could calculate that on a monthly, quarterly, or yearly basis.
For example, if you run a SaaS and the average customer spends £25/month and sticks around for 18 months, your LTV when working it out monthly would be:
25 (average spend per month)* 18 (months as a customer) = £450
Understanding your LTV means you know exactly how much you can afford to spend to acquire new customers. If your LTV is high, you can afford to spend more. If it’s low, you know you’ll need to be efficient with your budget.
The formula for customer acquisition costs (CAC) is:
Total Marketing Costs / Number of New Customers = CAC
You can calculate your CAC on a campaign-by-campaign basis to identify the most profitable channels for your company. For example, if you spend £10,000 on Facebook Ads and acquired 250 new paying customers, here’s how you’d calculate your CAC:
10,000 (total spend) / 125 (new customers) = 80
You’ll know exactly how much you spent to acquire each customer. In this case, £80.
If you want to assess your true CAC, you can also include costs like salaries, software, rent, and other costs involved with running your business.
CAC is vital to track because it affects how much you can afford to spend on marketing and estimate how many customers you can expect to acquire for your available budget.
Once you know your LTV and your CAC, it’s easy to find your LTV:CAC ratio. The formula is:
LTV / CAC = (#)LTV:(1)CAC
So, for example, if your LTV is £450 and your CAC is £80, you’d use the above formula to work it out:
450 / 80 = 5.6:1
So, for every £1 spent on marketing, you’re generating £5.60 in revenue.
It’s essential to look at CAC and LTV together; neither metric alone gives you insights into profitability. Your LTV:CAC ratio, on the other hand, does precisely that.
For most businesses, an LTV:CAC ratio of 3-5:1 is a good benchmark.
If your LTV:CAC ratio is much higher, for example, 10:1, it could indicate your business has significant profit margins, but it could also be an indicator that you have a clear product-market fit and can invest more resources into your sales and marketing efforts than you currently are.
If the ratio is too low, for example, 1:1, then you’re only breaking even on your marketing efforts but aren’t making any profits. That could be due to a high CAC or a low LTV.
If your LTV:CAC ratio isn’t high enough and it’s clear your marketing efforts aren’t profitable, you can decide how to improve your profitability.
This could mean testing new marketing channels to reduce your CAC or increasing your pricing, and working on new retention strategies to increase your LTV.
Tracking your LTV:CAC ratio across every marketing channel will give you granular details into which channels are performing best. From there, you can focus on channels driving long-term profitability.
For example, let’s say you’re running Facebook Ads and Google Ads.
It costs £20 to acquire a customer from Facebook Ads, and £50 from Google Ads.
Your customers acquired via Facebook spend an average of £100 per year, and your customers from Google spend an average of £150 per year with you.
At first glance, you might think that it’s worth investing more in Google Ads because those customers are spending more. However, if you looked at the LTV:CAC for both channels, you could work out which customer is truly more profitable.
Here, your LTV:CAC tells you that Facebook Ads drive more profitability for your company than Google Ads.
Metrics like ROAS (Return on Ad Spend) are commonly used to report on paid marketing channels. However, they don’t tell you everything, and looking at them in conjunction with your LTV:CAC ratio will help you understand if they’re truly moving the needle for your company.
For example, a campaign can deliver a positive ROAS, but that doesn’t necessarily mean it’s profitable enough to continue running when you account for all of your costs.
If you know your LTV:CAC, you can set benchmarks for what your ROAS needs to be to ensure profitability.
If you’re a brand new startup, your LTV:CAC won’t be completely accurate. You won’t know your true LTV for months – or years – as you won’t have significant data.
What’s more, your CAC for early customers may be higher than it is for customers you acquire six months later, as you won’t have the benefit of any brand awareness when acquiring those early customers.
Instead, focus on metrics like return on investment (ROI) and payback period (the number of months it takes to earn back the money invested in acquiring customers) as they’ll be the main ways to tell if your campaigns are profitable.
Over time, you can start to work out your LTV:CAC when you have more data on your average customer acquisition costs and how much your best customers spend with you.
Another common mistake is ignoring all of your customer acquisition costs.
Many founders and marketers will only consider direct costs like advertising spend when calculating their CAC. This can be misleading, resulting in an LTV:CAC ratio that understates your actual customer acquisition costs.
Make sure to incorporate every cost associated with acquiring your customers and serving them. If not, it’s easy to end up thinking you’re more profitable than you are.
LTV:CAC is a crucial metric to measure. Both LTV and CAC give you insights on their own. But when reviewed together, you’ll have an accurate picture of whether or not your marketing efforts are delivering profitability for your company.
Once you understand your LTV:CAC, you can identify your best marketing channels, your most profitable customer segments, and set clear targets to gauge the success of your marketing efforts.
If you need help finding or improving your LTV:CAC ratio, you can connect with vetted marketing experts on Traktion. You’ll get access to proven marketing talent with the skills you need to uncover growth opportunities and ensure your marketing efforts drive profitability.