LTV/CAC Ratio

What is the LTV/CAC ratio?

LTV/CAC ratio is the ratio of customer lifetime value (LTV) to the cost of acquiring a new customer (Customer Acquisition Cost, CAC). In German it is called the Verhältnis von Kundenwert zu Kundengewinnungskosten, and the notation LTV:CAC is also common. Customer lifetime value is the gross profit of a customer over the entire business relationship, and the acquisition cost is the sales and marketing cost incurred to win that customer. A value of 3 means that a customer generates three times what acquiring that customer cost.

The metric is one of the most important unit economics and is used above all for subscription software (SaaS) and other models with recurring revenue. From Series A onwards, it is one of the figures by which investors in funding rounds judge whether additional capital for customer acquisition creates value. Neither the numerator nor the denominator is defined by law, so the informative value depends on how they are delimited.

Calculating the LTV/CAC ratio: formula, numerator and denominator

Formula: LTV/CAC ratio = (monthly revenue per customer × gross margin / monthly churn rate) / (sales and marketing costs / number of new customers)

The numerator is the LTV, calculated on the basis of gross profit and customer churn. The gross margin is the share of revenue that remains after direct costs. The denominator is the total sales and marketing costs of a period, divided by the number of new customers won in the same period.

What belongs in customer acquisition costs

• Personnel costs in sales and marketing, including commissions, bonuses and employer social security contributions
• Spending on advertising, events, trade fairs and sponsorship
• Services of agencies and external sales partners, insofar as they serve to win new customers
• Sales tools such as a CRM system (software for managing customer contacts and sales opportunities) and address databases, as well as sales travel costs

The costs of serving existing customers do not belong in it, as long as they are not aimed at selling additional services. In young companies, the sales work of the management is often not recorded as sales costs because the salary is booked under administration. For a reliable metric, the share attributable to sales is allocated appropriately.

Average and channel-based values

If all new customers are divided into all sales and marketing costs, the result is average customer acquisition costs (blended CAC). They include customers who came through referrals or search engines without paid measures, and are therefore lower than the cost of a paid channel. For budget decisions, channel-based values are more informative: the cost of a channel divided by the new customers that can be attributed to it. This requires the source of each new customer to be recorded in the CRM.

In business with corporate customers, several months often lie between first contact and contract signing. The costs of one quarter then produce new customers of the following quarter. Many companies therefore calculate over a rolling twelve months or apply the costs with a time lag.

Benchmarks and interpretation of the LTV/CAC ratio

The metric answers the question of whether winning a customer pays off over the entire customer relationship. As a rule of thumb, the following classification applies:

• Below 1: A customer generates less than acquiring that customer costs. Additional growth increases the loss.
• 1 to 3: The acquisition costs are covered, but little remains for product development, administration and profit.
• 3 and above: the common benchmark for a sustainable model.
• Well above 5: not a best value, but a question about the level of investment and the assumptions.

The benchmark of 3 to 1 does not follow from any formula. It reflects that the gross profit of a customer must bear not only the acquisition costs but also fixed costs and the uncertainty of the forecast. Values are comparable only if calculated in the same way: a ratio determined with an LTV limited to five years is stricter than one under the unlimited basic formula.

Value and time

The ratio says whether a customer is worthwhile, but not when. With the simple formulas, a direct relationship applies: LTV/CAC equals the expected customer lifetime divided by the payback period. With a customer lifetime of 50 months and a payback of 15 months, the ratio is around 3.3. Two companies with the same ratio can therefore have very different capital requirements if their customers pay back at different speeds. The metric is therefore always read together with the CAC payback period.

The metric in funding rounds and valuation

In a funding round, the metric serves as evidence that the planned use of proceeds adds up. If a large part of the capital raised is to go into sales and marketing, every additional customer won must generate more than that customer costs. Investors also examine whether the ratio holds as the budget grows. Additional channels and new target groups are generally more expensive than the first, well-fitting customers.

For valuation, the metric is not a direct calculation factor, but it influences how investors classify growth. Growth with a ratio well above 3 is regarded as valuable and supports a higher revenue multiple, that is, a valuation at a higher multiple of revenue. Growth with a ratio close to 1, by contrast, is regarded as expensively bought, even if the revenue curve is steep.

Recalculation in due diligence

In due diligence, investors rebuild the metric from its components. For the denominator, they request sales and marketing costs by month and cost type. The basis is the trial balance, that is, the list of all bookkeeping accounts with their balances, and the personnel cost breakdown by function. The number of new customers is determined from the billing system or the CRM and reconciled with the customer list. For the numerator, cohort data and the reconciliation of the gross margin are used.

The main check is whether numerator and denominator relate to the same customer group and the same period. It is also clarified what counts as a new customer: a new subsidiary of an existing customer, a returning customer or a switch from a free plan are treated differently. Because numerator and denominator can be shaped, reviewers read an unusually high value first as a question about the method.

Worked example: LTV/CAC ratio of freight forwarding software

A company that sells software for freight forwarders won 140 new customers in the past twelve months. The sales and marketing costs of the same period consist of EUR 900,000 in personnel costs, EUR 300,000 for advertising and events, and EUR 60,000 for tools. A customer pays an average of EUR 500 per month, the gross margin is 80% and the monthly customer churn is 1.5%.

• Customer acquisition costs: (900,000 + 300,000 + 60,000) EUR / 140 = EUR 1,260,000 / 140 = EUR 9,000 per new customer.
• Gross profit per customer per month: EUR 500 × 0.80 = EUR 400.
• LTV: EUR 400 / 0.015 = around EUR 26,667.
• LTV/CAC ratio: EUR 26,667 / EUR 9,000 = around 2.96, so just under 3 to 1.
• Incorrect, with revenue instead of gross profit: EUR 500 / 0.015 = around EUR 33,333, ratio 33,333 / 9,000 = around 3.7.
• Incorrect, without personnel costs: EUR 360,000 / 140 = around EUR 2,571 per new customer, ratio 26,667 / 2,571 = around 10.4.
• Payback period for comparison: EUR 9,000 / EUR 400 = 22.5 months.

The same business basis yields, depending on the delimitation, a ratio between just under 3 and over 10. The relationship between customer lifetime and payback period confirms the correct value: 1 / 0.015 = 66.7 months, divided by 22.5 months, likewise gives around 2.96. Although the ratio is close to the widespread benchmark, each customer needs almost two years until the acquisition costs are covered. Measured against both benchmarks, at least 3 to 1 and a payback period under twelve months, the company narrowly misses the first and clearly misses the second.

Distinctions: LTV/CAC ratio, CAC payback, magic number and ROAS

• CAC payback period: measures the time until the acquisition costs are covered rather than the total value of a customer, and thus determines the capital requirement.
• Magic number: relates the net increase in annual recurring revenue to the sales and marketing costs of the previous quarter. It works with observed quarterly figures and needs no assumptions about customer lifetime.
• ROAS (Return on Advertising Spend): the revenue per euro of advertising spend on an individual advertising measure. It measures revenue rather than gross profit and usually only the first order, whereas the LTV/CAC ratio covers the entire customer relationship and all sales and marketing costs.

Common mistakes

• Numerator and denominator from different groups. The LTV of the entire customer base is set against the acquisition costs of a new segment whose customers are smaller or cancel faster.
• Personnel costs not recorded. Salaries and commissions are often the largest cost block in sales and marketing. Without them, the metric loses its informative value.
• Organic customers in the average. Referral customers lower the average acquisition costs and conceal that paid channels miss the benchmark.
• LTV on a revenue basis. The ratio rises by the reciprocal of the gross margin without any change in profitability.
• Time-lagged variables. If the budget rises, the costs arise immediately but the new customers only later, and the metric deteriorates temporarily. If the budget falls, it improves only in appearance.
• Introductory discounts overlooked. If LTV is calculated with list prices although new customers receive discounts in the first contract year, the numerator is too high.

Frequently asked questions

What is a good LTV/CAC ratio?

As a rule of thumb, a ratio of at least 3 to 1 is considered good. Values between 1 and 3 do cover the acquisition costs but leave little for fixed costs and profit. The value is meaningful only together with the method of calculation and with the CAC payback period, which shows how long the capital employed is tied up.

Is a ratio of 8 to 1 better than one of 3 to 1?

Not necessarily. A very high ratio can mean that the company leaves growth opportunities unused because it invests too little in sales and marketing. It is also often based on a customer lifetime in the LTV that is not supported by the history. In both cases, investors ask follow-up questions instead of accepting the value as a strength.

Does the metric also apply outside software?

Yes, wherever customers buy repeatedly, for example for subscriptions of consumer goods, for platforms and in recurring service business. In project business with one-off orders, the informative value is low, because no customer lifetime in the true sense can be determined.

How can the LTV/CAC ratio be improved?

Lower churn has a particularly strong effect, because it is in the denominator of the LTV and extends the customer lifetime. In addition, higher prices, expansion among existing customers and a better gross margin raise the numerator. Customer acquisition costs fall through a sharper selection of target customers (ICP), higher close rates and shorter sales cycles.

The Roemer Capital view

As a benchmark, we apply a ratio of at least 3 to 1, but only together with a CAC payback period of under twelve months. Only both values together show whether a growth plan is economically sound and how much capital it ties up until the acquisition costs are covered.

In preparing a funding round, we disclose which cost accounts enter the customer acquisition costs, how the sales work of the management is allocated and which churn rate is built into the customer value. A ratio that is reached only with the most favourable delimitation weakens the equity story more than a lower value that withstands any recalculation.