LTV to CAC Ratio

Customer lifetime value (LTV) is the gross margin a typical customer produces over the time they stay. It is divided by customer acquisition cost (CAC), the cost of acquiring each new customer, to show how many times over the business earns back what it spends to win them. The LTV to CAC calculation is a direct test of the business model: it shows whether growth is creating value or consuming cash.

A business can grow quickly by overspending to win customers who do not stay long enough to repay the cost. LTV to CAC exposes that. It guides how much the business can afford to spend on marketing (including ad spend), which customer segments to target and whether customer retention or acquisition deserves more attention. Investors and buyers use it as a shorthand for the quality of a growth model.

It works best alongside the payback period, which is the number of months of margin it takes to recover what each customer cost to win. A healthy ratio with a very long payback period can still put a strain on cash.

To calculate LTV, base lifetime value on gross margin, not revenue, and on actual customer retention data, not hopeful assumptions. Where delivery costs rise and fall with each customer, use contribution margin (revenue less all variable costs) instead, as it is closer to what a customer really earns. Estimate lifetime from the churn rate: a business losing 2% of its customers a month has an average lifetime of around 50 months.

Be cautious with young businesses: lifetime is hard to estimate until customers have been around for a while, so use a capped period such as three years. To calculate the LTV to CAC ratio properly, include all acquisition costs, not just ad spend, and divide by the number of new customers won in the same period.

Look at the ratio by segment and channel, as the average often hides segments that are unprofitable to win. To improve your LTV to CAC, either increase lifetime value (reduce churn, raise prices, lift margin) or lower the cost of winning each customer.