The Beginners Guide to LTV & CAC

LTV and CAC might sound like absolute gibberish to the uninitiated. However, these are two powerful marketing metrics that business owners should never ignore. Without them, your marketing becomes a complete stab in the dark. 

So what are these metrics, what do they tell us, and how can we use them? Read on to discover answers to all these questions and more. And as always, expect plenty of helpful tips and tricks along the way. Enjoy!

What exactly is LTV?‍

LTV stands for Lifetime Value. This metric gives you an accurate idea of how much money a customer will spend throughout their entire relationship with your business. Typically speaking, the higher your LTV, the better. 

Why track LTV?

'Why track LTV?' we hear you ask! Well, the real question is, why wouldn't you?

On its surface, LTV reveals how well your business is performing. A high LTV is often a great indicator of excellent business performance. But LTV can show us so much more than that.

When used correctly, LTV exposes who should be the focus of your marketing. If your business is receiving an above average LTV with a specific demographic, they should become the main focus of your marketing. 

Another of LTV's neat tricks is that it can tell you precisely how many new customers you need to gain to make your business profitable. Pretty handy stuff! Here's how it's done:

1. Calculate your yearly running costs (RC)
2. Calculate your average customer LTV
3. Divide your running costs by your LTV
4. You now know the number of customers you need to break even 

Break even formula: RC ÷ LTV = number of customers required to break even 

Exercise

Question: Pretend you run a SaaS company. Your yearly running costs are £12,000. Meanwhile, your average customer LTV is £500. How many customers do you need to break even?

Answer: 24. 

Why? Because: 

• £12,000 (RC) ÷ £500 (LTV) = 24
  

How to calculate your LTV?

Now that you're all clued up on what LTV is and does, let's explore how to calculate it. Grab your calculators and follow along because here's what you need to do:

1. Calculate your monthly ARPU (Average Revenue Per User). To do this, add up your monthly revenue and divide it by the number of customers you have. 
2. Multiply your monthly ARPU by your ACL (Average Customer Lifetime)
3. Congrats! You now know your LTV

LTV formula: ARPU X ACL = LTV

Exercise

Question: Pretend you run a brick and mortar shoe store. Your ARPU is £50. Meanwhile, your average customer lifetime is 3 months. What is your LTV?

Answer: £150

Why? Because: 

• £50 (ARPU) X 3 (ACL) = £150
  

Top tip

You can calculate LTV to look at your entire customer base or focus in on particular demographics. Try calculating your LTV for different age groups, genders or professions to see how they compare. 

What exactly is CAC?

‍CAC stands for Customer Acquisition Cost. It's a metric that tells you how much money your business needs to spend to land a new customer. Typically speaking, the lower your CAC, the better. 

Unlike LTV, CAC can frequently change over time. Make sure to monitor this KPI monthly for the best results. 

Why track CAC?

Most importantly, CAC reveals the costs of acquiring customers — an invaluable piece of data when planning for the future of your business. But it can also show you how well your marketing and sales process works. 

For example, tracking your CAC might show you that your CAC is low or decreasing. This is great news and an indicator of a well-oiled marketing machine. Keep doing whatever you're doing! 

On the other hand, tracking your CAC might reveal that your CAC is high or increasing. This is a red flag and an indicator that something in your marketing and sales process needs changing. 

How to calculate your CAC

Intrigued to discover how to calculate the order metric that is CAC? Well, today's your lucky day because here's how it's done:

1. Calculate your marketing expenses
2. Calculate your sales expenses
3. Add your marketing and sales expenses together
4. Divide your combined marketing and sales expenses by the number of customers you acquired
5. Congrats! You now have your CAC

CAC formula: Expenses ÷ customers acquired = CAC

When calculating your CAC, stick to a defined time period. For example, a specific week, month or year.

Exercise

Question: Pretend you run an online book store. Last year your annual marketing expenses were £15,000. Your annual sales expenses were £20,000. And, throughout the year, you acquired 1,000 new customers. What was your annual CAC?

Answer: £35

Why? Because:

• £15,000 (marketing expenses) + £20,000 (sales expenses) = £35,000 (combined expenses)
• £35,000 (combined expenses) ÷ 1,000 (new customers) = £35
  

Top tip

You can calculate your CAC for specific marketing channels, e.g. ads, social media, podcasts, etc. Try calculating your CAC across all of your channels to see how they compare. 

LTV Vs CAC — Which one should I track?

We've discussed two compelling metrics today. So, now the question is, which one will you choose to track?

If your answer is both, give yourself a pat on the back! While we could debate the virtues and detriments of each metric all day long, the truth might surprise you. Like many things in life, LTV and CAC are better when they're together.

Why?

Because when you put these two metrics together, you get a clear picture of whether you're wasting your money or raking it in. 

Remember when we told you that LTV tracks how much customers spend throughout their entire relationship with you? And when we said CAC tracks the cost of acquiring those customers? Well, what would happen if your CAC was higher than your LTV? On the other hand, what would it mean if your CAC was lower than your LTV? Let's explore:

• If your CAC is higher than your LTV — you're losing money. It costs you more to acquire each customer than they're spending.
• If your CAC is lower than your LTV — you're making money. Each customer you gain is spending more money than the cost of acquiring them. 
  

Exercise

Question: Pretend you're the owner of an online jewellery shop. Your average customer LTV is £1,000. Meanwhile, your CAC is £500. Is your shop making or losing money?

Answer: It's making money!

Why? Because:

• Your LTV of £1,000 is higher than your CAC of £500
  

Introducing the LTV:CAC ratio

In the previous section, we discussed how using LTV and CAC together will reveal whether you're making profits or taking losses. Now, it's time to take things a step further by introducing the LTV:CAC ratio.

First off, let's explain how the LTV:CAC ratio works. If you have an LTV:CAC ratio of 5:1, it means that for every £1 you spend, you'll make back £5. Alternatively, a ratio of 4:1 would mean that for every £1 you spend, you'd see £4 back.

Exercise

Question: Your sportswear brand has an LTV:CAC ratio of 3:1. For every £1 you spend, how much money do you make back?

Answer: £3

Why? Because:

• Your Lifetime Value is 3X higher than your Customer Acquisition Cost
• Therefore, for every £1 you spend, you make a £3 return
  

What does the perfect LTV:CAC ratio look like?

Now that you understand how LTV:CAC ratios work, let's explore each ratio's meaning to your business. 

Let's start at the low end with an LTV:CAC of 1:1. This ratio is terrible news. For every £1 you spend, you're making £1 back. There are no profits. With this ratio, you lose money the more that you sell. 

Now let's look at an LTV:CAC of 2:1. This ratio might look great on paper as you are doubling your money. However, things aren't quite perfect. Taking into account your running costs, you're risking minuscule profits. 

Now for the opposite end of the spectrum. An LTV:CAC of 5:1 looks fantastic. For every £1 you spend, you're making a £5 return. That's great news, right? Well, not quite. An LTV heavy ratio often indicates that your underspending on your marketing, which limits growth. So, if you have a ratio of 5:1 or higher, consider increasing your marketing spend.

And now for the ratio, we've all been waiting for. The perfect, golden LTV:CAC ratio worth crying over! So, what is it then?

The perfect LTV:CAC ratio is 3:1. Most successful businesses aim to make returns 3 times higher than their initial investment. Any further profits are reinvested into their marketing machine to attract more customers and, in turn, drive higher profits. 

The Owlee solution

Nailing your dream LTV and CAC metrics doesn't just happen overnight. That being said, a lot can be done to boost your chances.

Owlee is an automated digital advertising platform for acquiring new and repeat customers en masse. Unlike other platforms, Owlee can tell you precisely how many customers each campaign will earn for you, giving you a clear picture of CAC before you even hit launch. 

So, whether you're an entrepreneur, small business owner or marketing maverick, why not give Owlee a go?

Conclusion

We hope we've managed to answer all your questions about LTV and CAC. They're two of the most important KPIs any business owner can track, shining a bright light on how your business is truly performing.

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