Guide · 3 min read ·
LTV to CAC ratio: what is a good number and how to improve it
Every subscription business faces the same question: how much can we spend to win a customer and still make money? Two numbers answer it. Lifetime value, or LTV, is what a customer is worth. Customer acquisition cost, or CAC, is what it costs to get one. Their ratio is one of the most quoted health checks in SaaS, and this guide shows how to use it without fooling yourself.
What LTV is and how it is worked out
Customer lifetime value is the gross profit you expect from an average customer over the whole time they stay. A simple way to calculate it is monthly revenue per account multiplied by gross margin, divided by monthly churn. A customer paying 50 dollars a month at an 80 percent margin who churns 4 percent a month is worth 50 times 0.8 divided by 0.04, which is 1,000 dollars.
Using gross profit and not revenue matters. Revenue ignores what it costs you to serve the customer, so a ratio built on revenue looks better than reality.
What CAC includes
CAC is the total sales and marketing cost over a period divided by the new customers you won in it. Include everything you spend to win customers: ad spend, tools, commissions, the salary of people who sell and market, and the cost of free trials if they are significant. Leaving out time and salaries is the most common way founders understate CAC.
If you are early and every customer comes from your own outreach, your time still has a cost. Put a sensible hourly value on it so the number is honest.
The ratio and the usual targets
Divide LTV by CAC. A ratio of 3 to 1 or better is the most common rule of thumb for a healthy subscription business. Below 1 you lose money on every customer. Between 1 and 3 you may be profitable on paper but with little room for error. Far above 5 can mean you are under investing, and could grow faster by spending more.
CAC payback is a useful companion. It is the number of months of gross profit needed to earn back what you spent to win the customer. Many teams aim for 12 months or less, and shorter is safer for a business with little cash. Treat both targets as guidelines, not laws, since they vary with industry and funding.
Why early numbers can mislead
The formula depends on churn, and churn is hard to measure when you only have a few months of data. With a small number of customers, one cancellation can move your figure a lot. If you have little history, run the calculator with a few different churn values and see how sensitive the answer is. A ratio that only works at your most optimistic churn is not a safe one.
Ways to improve the ratio
There are two sides to the fraction, and you can work on either.
- Raise price or add paid extras to lift revenue per account.
- Reduce churn with better onboarding, support and failed payment recovery.
- Improve gross margin by cutting hosting and support cost per customer.
- Lower CAC by focusing on channels that bring customers who stay, such as search, referrals and directories.
- Shorten the sales cycle so people pay sooner.
Mistakes to avoid
Blending free and paid sources hides the truth. A free directory listing that brings customers at almost no cost makes your average CAC look better than your paid ads really are, so look at each channel on its own. Another mistake is using revenue and not profit. A third is calculating once and forgetting about it. Costs and churn drift, so recheck every quarter.
Keep going
Make sure your inputs are solid by measuring churn and MRR properly first. Low cost channels improve your ratio fastest, and a listing on a startup directory is among the cheapest there is, so claim your free tile on CircleSaaS and see what it brings.