The LTV:CAC Ratio – Evaluating Customer Acquisition Cost
Hi, it’s Rebecca Schuette with SmartBooks. Last week I talked to you about calculating the customer acquisition cost or CAC for your business.
How CAC Relates to LTV
When we talked about this last week, we calculated that customer acquisition cost in real dollars. While this is an important metric for you to understand about your business, what’s even more useful is understanding how that CAC, customer acquisition cost, relates to your LTV, or lifetime value of your customers.
Now what does that actually mean? Well, look at it this way. If you spend $1,000 to bring in a customer who generates $10,000 in lifetime value for your business, well that makes sound financial sense. If however, you spend that same $1,000 and are able to bring on a customer who only generates $500 in lifetime value for your business, well that’s not going to be a sound decision.
How Do You Calculate the LTV:CAC Ratio?
So how do you actually do this calculation? Well, first you need to figure out your lifetime value. You do that by looking at the average revenue per customer that you bring in on an annual basis and you multiply that by the average lifespan that those businesses are engaging with your company, come up with that calculation and you have your lifetime value. Then you want to divide your lifetime value by your customer acquisition costs.
LTV:CAC Ratio Benchmarks
At the end of that calculation, you’ll be left with a ratio. Now whether that ratio is beneficial for your business will rely on a whole bunch of criteria. For a professional services business, like ourselves, a good ratio is about seven to 10 times the cost of your customer acquisition for your lifetime value. You do that, you’ll be in decent shape in terms of profitability.
If however, you are say a venture backed software company, you’re early in your growth stage and you’re wanting to test out whether you have a profitable model and a business and a product that hunts in the market, then maybe you can shift this a bit lower, more like a ratio of three to five.
That’s about it for today. If you need help calculating your LTV:CAC Ratio, the team at SmartBooks is happy to help. Contact us today.