How to Calculate Customer Acquisition Cost Ratio (CAC Ratio)

How can you evaluate the success or failure of your sales and marketing campaigns? Are they worth the money you’re putting into them? Or is the payback period so long that you should shift tactics? There’s only one way to know for sure, and that’s by figuring out how long it takes to effectively pay back your costs with the money earned from the new sales generated by your sales and marketing efforts.

What is the CAC Ratio?

The customer acquisition cost (CAC) ratio is a comparison of two factors: the total sales and marketing expenses associated with gaining a new customer, and the incremental increase in the gross margin associated with those new customers during a given period of time.

How to calculate your CAC Ratio

Here is the formula for calculating your CAC ratio:

([Gross Margin Q2 – Gross MarginQ1] × 4) / Sales and Marketing Expenses for period Q2

Notice the numerator is expressed as an annualized number. We do this for a couple of reasons. When analyzing a company, we often look at how the company is performing each year and therefore use the year as the period for comparison. Additionally, products sold by most SaaS companies tend to have annual contracts. Therefore, it makes sense for our metric to match this time period.

Let’s look at an example:

In August, SaaS Co., an online social networking platform for SaaS entrepreneurs, spent $1,000 on pay-per-click advertising, $3,000 for print advertisements, and $6,000 for one Sales Representative to reach out to the leads generated from the new marketing campaign. Through the outreach and marketing, SaaS Co. generated 100 new customers, all of which purchased annual subscriptions for $5/month. We also know that SaaS Co.’s product is fully developed and only costs $50/month for unlimited hosting. Here’s a breakdown of their key financials:

SaaS Co.
Jul-15 Aug-15
Revenue
    Monthly Subscription 23,500 24,000
Total Revenue 23,500 24,000
COGS: Hosting 50 50
Total COGS 50 50
Gross Margin 23,450 23,950
Sales and Marketing
    Pay Per Click 1,000 1,000
    Print Ads 3,000 3,000
    Sales Rep Salary 6,000 6,000
Total Sales and Marketing 10,000 10,000

From this, we can see that the business has an increase in the gross margin of $500, or $6,000 when annualized. We also know the total sales and marketing expenses were $10,000 for the month. Based on these numbers, we can calculate the following:

(Annualized Incremental Gross Margin: $6,000) / (Total Sales and Marketing: $10,000)

= 60% CAC Ratio

What does this mean? It means that the new customers acquired that month will recover 60% of the month’s sales and marketing efforts in one year. It can also be useful to flip the numerator and denominator to see a different result. Doing so yields the following:

(Total Sales and Marketing: $10,000) / (Annualized Incremental Gross Income: $6,000)

= 1.67 Inverted CAC Ratio
(Payback Period)

The inverted CAC ratio tells us how many years—in this case, 1.67 years—it will take SaaS Co. to recover its initial investment in sales and marketing for August. At Lighter Capital, we use the inverted ratio most often because it gives us a faster way to review the amount of time it will take to recover a company’s investment in sales and marketing.

Note that in this example, we assumed that all new customers acquired in August were a direct result of sales and marketing efforts in August. However, most businesses have a lag time between the sales and marketing efforts and actual sales. Directly matching the revenue earned with respective sales and marketing spend can be challenging and time consuming, so simplifying it as shown above can serve as a helpful proxy.


Want More SaaS Metrics?

The 8 SaaS Metrics That MatterWant a more comprehensive look at the most important metrics investors look for when funding tech companies? There are many numbers, statistics, and metrics to calculate, track and assess the health of your technology business; so many, in fact, that reliable measurement can seem overwhelming.

This guide explains the core metrics used to measure SaaS company success. Using simple examples, we’ll show you how to calculate each metric, and describe why specific indicators are important to investors.