LTV (Customer Lifetime Value)

What is LTV?

LTV (Customer Lifetime Value) is the amount a customer contributes over the entire duration of the business relationship after deducting the direct costs of serving that customer. In German the metric is called Kundenwert or Kundenlebenszeitwert, and the abbreviations CLV and CLTV are also in common use. The calculation therefore does not use revenue, but the part that remains after those costs: the gross profit (in German, Bruttoergebnis or Rohertrag).

LTV is one of the Unit Economics, the profitability analysis per customer. It is used in business models with recurring revenue, above all subscription software (SaaS), but also for platforms and consumer goods with repeat purchases. It appears in the financial model, the pitch deck and the KPI report to investors, and it is recalculated in the financial and market-related due diligence. It is not defined by law and does not appear in annual financial statements under the German Commercial Code (Handelsgesetzbuch, HGB). Every figure must therefore disclose how it was calculated.

Calculating LTV: formula and variants

Formula: LTV = monthly revenue per customer × gross margin / monthly churn rate

Revenue per customer is usually taken as the average recurring revenue per customer account (ARPA). The gross margin is the share of revenue that remains after direct costs. Dividing by the churn rate (churn rate) replaces the average customer lifetime, which, with constant churn, equals the reciprocal of the rate. An example: a customer pays EUR 100 per month, serving that customer costs EUR 25, and 2% of customers cancel every month. A customer then stays for an average of 1 / 0.02 = 50 months, and the LTV is EUR 75 × 50 = EUR 3,750. The formula assumes constant churn and constant revenue per customer.

Gross margin instead of revenue

For subscription software, direct costs consist mainly of data centre and cloud costs, licences for integrated third-party software, payment processing fees and technical customer support in ongoing operation. Sales, product development and administration are funded from the remaining gross profit. Anyone who calculates LTV on a revenue basis overstates it by a factor of 1 / gross margin, which for a gross margin of 75% means by one third.

The gross margin cannot always be read from the annual financial statements. Only the cost of sales method reports a gross profit from sales (Section 275(3) HGB). Many German companies, however, structure their income statement by the nature of expense method (Section 275(2) HGB), that is, by types of expense. The gross margin then results from a traceable allocation of the expense accounts.

Variants of the calculation

• Limited time horizon: Instead of a theoretically unlimited term, the expected gross profit is summed up only over a fixed period, as a rule of thumb three to five years. Churn within this period remains taken into account.
• Discounting: Future gross profits are discounted to the present using a cost of capital rate. In simplified form, the monthly discount rate is added to the churn rate: LTV = monthly gross profit / (monthly churn rate + monthly discount rate).
• Cohort-based LTV: Instead of a formula, the cumulative gross profit per customer actually observed for an entry cohort after 12, 24 or 36 months is evaluated (cohort analysis). The result rests on observation rather than assumptions, but extends only as far as the history.
• Revenue churn instead of customer churn: Instead of the share of customers who cancel, the share of recurring revenue that is lost is used, either gross (cancellations and downgrades) or net (less expansion among existing customers).
• Business without subscriptions: In repeat-purchase models, purchase frequency replaces monthly revenue. The calculation uses average order value (AOV) × gross margin × orders per year × expected years of the customer relationship.

LTV in a funding round and valuation

On its own, LTV has little informative value. Investors read it as the numerator of the LTV/CAC ratio, that is, in relation to the cost of acquiring a customer. Only this comparison shows whether additional capital for sales and marketing creates value or merely buys revenue. When the acquisition costs are earned back is shown by the CAC payback period. In a funding round, a reliable LTV substantiates the planned use of proceeds for customer acquisition.

A valuation model based on discounted future cash surpluses (discounted cash flow) derives the revenue of the customer base from the same assumptions on churn and expansion. If LTV and the valuation model rest on identical assumptions, they support each other. After a company acquisition, the customer base is often valued separately in the purchase price allocation, the allocation of the purchase price to the acquired assets.

How investors examine LTV

Investors recalculate LTV from raw data and compare their result with the company's figure. The basis is a customer-level revenue list by month from the billing system, reconciled with the booked revenue, the cohort table and a reconciliation of the gross margin from the bookkeeping. If the sum of customer revenues differs from the revenue accounts, the difference must be explained before LTV is discussed.

Three points need to be clarified in the definition. The first is what counts as a customer: contracting party, group or individual user account. The second concerns revenue: set-up fees and consulting arise only once and do not belong in a figure that is multiplied by the customer lifetime. The third is which costs fall into the gross margin, above all technical support, onboarding and customer service. For the customer definition and the cost allocation, any decision is defensible as long as it is disclosed and made in the same way in all periods.

LTV is regarded as particularly open to manipulation because the churn rate is in the denominator: if it falls from 2% to 1.5%, LTV rises by one third. Reviewers therefore check whether the rate comes from a favourable segment or a short period and whether list prices rather than invoiced prices are used. A sensitivity analysis with higher churn is customary.

Worked example: calculating the LTV of planning software

A provider of planning software for medium-sized manufacturing companies earns an average of EUR 600 in recurring revenue per month from its customers. The gross margin is 75%. On average over the last twelve months, 1.5% of customers cancel each month.

• Gross profit per customer per month: EUR 600 × 0.75 = EUR 450.
• Expected customer lifetime: 1 / 0.015 = around 66.7 months, or a good five and a half years.
• LTV under the basic formula: EUR 450 / 0.015 = EUR 30,000.
• Incorrectly calculated on a revenue basis: EUR 600 / 0.015 = EUR 40,000, that is EUR 10,000 or one third too much.
• Limitation to 36 months: after 36 months, 0.985 to the power of 36 = around 0.580, or 58%, of a customer group is still present. The expected gross profit of the first 36 months is EUR 450 × (1 minus 0.580) / 0.015 = around EUR 12,600.
• With discounting (cost of capital assumed at 10% a year, around 0.8% a month): EUR 450 / (0.015 + 0.008) = around EUR 19,600. That is about one third less than under the basic formula.

The method alone produces a range of EUR 12,600 to EUR 30,000 here. The basic formula allocates more than half of the customer value to the years after the third contract year, which a company with twelve months of observation cannot yet substantiate. With acquisition costs of EUR 10,000 per customer, the basic formula would give a ratio of 3 to 1. The discounted value would come to just under 2 to 1, the calculation over 36 months to around 1.3 to 1. Investors therefore expect, alongside LTV, a statement of the history on which the churn rate is based and the value over a limited period.

Distinctions: LTV, contribution margin, ARPA, ACV and loan to value

• Contribution margin: Revenue less all variable costs. Some presentations of unit economics calculate LTV on this basis. If the chosen level deducts further variable costs, such as revenue-based commissions, LTV is lower than on the basis of gross profit. The chosen level must be stated.
• ARPA: the average revenue per customer account and thus only one input of LTV. It says nothing about margin and customer lifetime.
• ACV (Annual Contract Value): the annual value of a single contract. LTV extends over several contract periods and takes the probability of renewal into account.
• Loan to value: In real estate and credit financing, the same abbreviation LTV stands for the loan-to-value ratio (in German, Beleihungsauslauf), that is, the ratio of the loan to the value of the financed property or collateral. This metric has nothing to do with customer value.

Common mistakes

• Revenue instead of gross profit. LTV appears too high by the reciprocal of the gross margin. With a gross margin of 60%, the stated value is two thirds above the correct one.
• Unlimited extrapolation. With low churn, the basic formula yields customer lifetimes of eight or ten years, which no young company can substantiate.
• Churn from a short history. A rate from a few months is statistically uncertain. Minimum contract terms additionally bias it downwards, because customers cannot cancel during this time.
• One value for all segments. Large and small customers differ in revenue, margin and churn. A common average describes neither segment accurately.
• Incomplete direct costs. If support and onboarding are booked under administration or product development, the gross margin rises arithmetically without any change in the profitability of the customer.

Frequently asked questions

What is a good LTV?

As a rule of thumb, an LTV is considered good if it reaches at least three times the customer acquisition cost (CAC). There is no absolute target value, because the level only means something in relation to these costs. A customer value of EUR 3,000 is comfortable with acquisition costs of EUR 500; at EUR 2,500, almost nothing is left beyond acquisition for fixed costs and profit.

Which churn rate belongs in the LTV formula?

In the basic formula, monthly customer churn, because it describes how long a customer stays on average. Gross revenue churn is appropriate when customers differ greatly in size or when downgrades matter. Net revenue churn is suitable only with a limited time horizon, because it can become zero or negative, in which case the basic formula no longer yields a value. Revenue and churn rate must relate to the same period, that is, both monthly or both annual.

Over what period is LTV calculated?

As a rule of thumb, over three to five years or over the calculated customer lifetime if that is shorter. What matters is which period the observed data support. A customer lifetime that extends far beyond the company's history rests on an assumption and is to be labelled as such.

Does LTV have to be discounted?

Not necessarily for a management metric. For customer lifetimes of several years and when used in a valuation, discounting is appropriate, because a gross profit in the fifth year is worth less than one in the first. LTV and customer acquisition costs must then be compared on the same basis.

When is an LTV reliable?

As a rule of thumb, when several cohorts have been observed for at least twelve months and churn has visibly stabilised. Before that, LTV is a planning assumption. It can still be shown, but should then be labelled as an assumption and supplemented by a cautious variant. It is recalculated at least quarterly, because price changes and new customer groups shift the inputs.

The Roemer Capital view

In our clients' financial models, LTV never appears without the churn rate from which it is derived, and never without a comparison value over a limited period. We derive the gross margin from the bookkeeping and reconcile it with the annual financial statements and the ongoing management reporting rather than setting it as a plan value. This allows the metric to withstand a recalculation in due diligence.

Unit economics are one of the four pillars by which we assess whether a company is ready for investors. For us, LTV is a result of price, gross margin and churn, not a goal in itself. Where it is weak, we work with the management on these three variables before the process begins. As a benchmark against customer acquisition costs, we apply at least 3 to 1.