As a SaaS entrepreneur, there are countless numbers, statistics, and metrics that you need to track and calculate to assess the health of your business, but the sheer number of acronyms can be overwhelming. In this series on key SaaS metrics, we walk you through the most common—and helpful—metrics you need to know to successfully run and grow your SaaS.

How effective is your sales and marketing? How much does it cost to bring in new customers—and how does that compare to what you expect to earn from customers over their lifetime? Looking at your CLTV/CAC Ratio can yield insights into how efficiently your company is spending its sales, marketing, and customer retention dollars and, in the long term, how valuable your company is. It can also tell you whether or not you’re in a strong enough position to lure in equity investors.

 

What is the CLTV/CAC Ratio?

The CLTV/CAC Ratio is the total average value you expect to receive from a new customer compared to the average cost to acquire a new customer.

  • CLTV = Customer Lifetime Value
  • CAC = Customer Acquisition Cost

 

Why CLTV/CAC is important

The CLTV/CAC ratio summarizes a plethora of information—including anticipated average lifetime revenue per customer, customer churn, and sales and marketing costs—into a single number that can be easily understood and used to evaluate the future prospects of your business.

For example, a high CLTV/CAC ratio means you have the potential to grow faster—and need less capital to do so. Companies with higher CLTV/CAC ratios typically have higher valuations and an easier time securing funding from investors.

A lower CLTV/CAC ratio means your company is not as efficient at acquiring high value customers, and will likely need more capital to fuel revenue growth. The need for more capital and the slower growth rate means lower valuations from investors.

 

How to calculate CLTV/CAC

There are several ways to calculate CLTV. One way is with this formula:

CLTV = Average Revenue per Account (ARPA) / Customer Churn

Or you can calculate CLTV using this formula:

CLTV = Average Revenue per Account (ARPA) × Average Customer Lifetime

For example, SaaSy Co. offers three different pricing options for its CRM software: basic, professional, and enterprise. SaaSy Co. has 100 basic customers, 250 professional customers, and 75 enterprise customers. Its average customer lifetime varies by pricing plan.

Pricing Plans Pricing Average Customer Lifetime
Basic $50/month 12 months
Professional $100/month 18 months
Enterprise $500/month 24 months

 

With this data, we can calculate the CLTV of the company’s average customer:

CLTV = [($50 × 100 × 12) + ($100 × 250 × 18) + ($500 × 75 × 24)] / 425 = $3,318

This means that, on average, SaaSy Co. can expect to generate $3,318 in revenue per customer.

CAC is simply: Total Sales and Marketing expense / # of new customers

For example, if SaaSy Co. spends $200k to acquire 160 new customers, their CAC would be $1,250 / customer.

So, putting it all together, SaaSy Co.’s CLTV/CAC ratio is $3,318 / $1,250 = 2.65

Note: Sometimes a gross margin adjustment is made to CLTV in order to compare gross profit to customer acquisition cost, rather than comparing revenue to acquisition cost. For high margin businesses, this adjustment is often ignored.

 

Rule of Thumb

So, what is a high/low CLTV/CAC ratio? Although average CLTV/CAC ratios vary across industries and business models, a general rule of thumb is that you should aim for a CLTV/CAC ratio of at least 3:1, especially if seeking equity investors. This provides the necessary profit to invest in continued growth, and allows for a cushion should CLTV decrease or CAC increase.

However, this is not to say that a business cannot thrive with a CLTV/CAC ratio of less than 3. If you do not desire or need a large exit, and if you’re not looking to raise equity, having a high CLTV/CAC ratio is less important. Debt investors, for example, are more interested in seeing a stable or slightly expanding CLTV/CAC ratio than a CLTV/CAC that’s greater than or equal to 3.

Want more metrics?

Download our guide, The 8 SaaS Metrics that Matter, to learn more about calculating metrics and using them to quantify your company’s successes for investors.

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