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The SaaS Finance Leader's Guide To LTV and CAC

June 11, 2021 Evan Webster  
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If you work at a fast-growing SaaS organization, you might have heard your CEO talk about customer lifetime value (LTV) and customer acquisition cost (CAC) at your last town hall meeting. While traditionally thought of as sales and marketing metrics, both LTV and CAC are becoming a focus for finance teams too as SaaS firms start to adopt a holistic approach to measuring their performance. 

The intensifying focus on LTV, CAC and the unique relationship between them might have you thinking—what exactly are these metrics and why should our finance team be tracking them? 

Every SaaS company will have their own approach to LTV and CAC based on their market, business model and growth stage. But some key principles ring true for all SaaS finance leaders who are looking to leverage their data to drive strategic decision making—and that’s what this article is all about.

But first, let’s start by defining LTV, CAC and the LTV to CAC ratio.

What Is Customer Lifetime Value? (LTV)

LTV is the average revenue earned from individual customer relationships, spanning from the moment a customer signs to the moment they churn. Actively measuring LTV allows you to answer two crucial questions: 1) How much revenue are we getting from clients over the course of their time with us and 2) How much revenue can I expect to generate from new customers? 

To calculate LTV accurately, you need to account for key inputs like average revenue per customer, gross profit margin and average customer lifespan. For B2C SaaS companies, you also need to consider the average purchase value and average purchase frequency when measuring LTV. 

Let’s say, for example, that your SaaS firm has an average ARR of $30,000 per customer. If gross profit margin is 70% with an average customer lifespan of four years, then LTV could be calculated using the following formula:

LTV = (average revenue per customer) x (gross profit margin) x (average customer lifespan)

       = ($30,000) x (0.70) x 4

       = $84,000  

What Is Customer Acquisition Cost? (CAC)

CAC is the average amount of money that a company spends to acquire a new customer. This metric is a little more straightforward than LTV, in the sense that SaaS businesses across industries generally require the same high-level inputs to determine their CAC. 

To accurately calculate CAC for a specific time period (usually per year or per quarter), you need to account for total sales expenses, total marketing expenses and total number of new customers acquired during that time. Keep in mind that effectively measuring sales and marketing costs includes advertising spend and employee payroll for all revenue-generating roles.  

A company’s CAC can be calculated using this formula:

CAC = (total sales expenses + total marketing expenses) / (total number of new customers)

What is the LTV to CAC ratio? (LTV:CAC)

LTV:CAC is the ratio that compares the lifetime value of customers to the costs associated with acquiring them. This is an important metric for gauging your company’s long-term profitability. 

Generally speaking, the benchmark for a strong LTV:CAC is 3:1—which means the value of your customer relationships should be about three times the cost of bringing those customers on board. Even though what’s considered to be a “normal” LTV:CAC will vary slightly between industries, you should look at the 3:1 benchmark as a pretty reliable indicator of whether or not your SaaS business is well-positioned for success. 

3 Reasons Your SaaS Finance Team Should Be Tracking LTV and CAC

As more and more SaaS companies start to dominate the digital economy, more conversations about LTV and CAC will start happening in boardrooms around the world. For finance leaders and CFOs—who are continuing to evolve from number crunchers into strategic, data-driven decision makers—this represents an incredible opportunity to start leveraging LTV and CAC data to help determine the path forward for your SaaS business. 

So, if you haven’t started already, here’s why your finance team should start paying attention to LTV and CAC and actively share those insights with the rest of your organization.

1. It Helps Influence Key Business Decisions

In a 2019 article, Forbes Council Member and Fattmerchant Co-founder Sal Rehmetullah said, “CAC and LTV are the two most crucial metrics for CFOs to track because they dictate your sales strategies.” While this is certainly true, the sales department isn’t the only area where LTV and CAC insights can deliver value.

Your finance team should also rely on LTV and CAC to identify strategic investment opportunities in marketing, operations and customer service. Let’s say, for example, that your company’s LTV:CAC starts to dip below that 3:1 benchmark. If you look at the reasons why, you might find that LTV is getting dragged down by an increase in churn rate. That level of insight would help your leadership team figure out what they need to prioritize—such as investing in product updates or expanding customer retention programs. 

On the other hand, if your company’s LTV:CAC is well above that 3:1 benchmark, there might be an opportunity for further investment in marketing and demand-generation initiatives without sacrificing profitability. Your finance team needs to own that analysis during your budgeting, forecasting and planning cycles—because as the stewards of financial data, you’re well-positioned to report on how changes to LTV:CAC might affect your SaaS company’s long-term goals.     

The challenge, however, is when financial and operational data is siloed in a bunch of different source systems. Executives will expect you to deliver LTV and CAC insights quickly—especially in fast-moving SaaS environments—which is a lot harder to do when you’re wrangling data manually with spreadsheets. 

But, you can solve this problem if you…

Integrate Your Data Sources and Build One Source of Truth for Financial and Operational Data 

That’ll make it easier to keep track of the inputs you need for LTV and CAC (revenue per customer, sales / marketing expenses, etc.) and to quickly model the impact when any of those inputs change. 

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2. It Encourages Transparency and Collaboration Between Departments

Tracking LTV and CAC requires data from across your business, which means you can foster cross-functional collaboration when it’s time to act on your findings. As we mentioned earlier, LTV:CAC is an indicator of your SaaS company’s profitability—and tracking it effectively ensures leaders from every department have proper visibility into how their teams are moving the needle.

Let’s say, for example, that your CAC is unusually high one quarter, perhaps due to a big bump in marketing spend that just didn’t translate to new customers for some reason. That scenario would negatively impact your LTV:CAC—and it would be up to your finance team to engage with marketing executives to show them how their trends are affecting the bottom-line.

It’s also important to remember that with more transparency around LTV:CAC, cross-functional leaders can hold their teams accountable by proactively analyzing how their departments are performing. After all, transparency is a two-way street—if non-finance leaders can identify for themselves how to make positive changes to your LTV:CAC, they’ll feel more comfortable working with your finance team (and other departments as well) to develop a solid game plan and improve the business altogether.   

3. You Can Help Lead Your SaaS Company’s Business Intelligence Revolution

In order to drive collaboration and make LTV and CAC easier to understand, data visualization with dashboards should be a prominent aspect of your business intelligence strategy.

Dashboards are really useful for simplifying metrics such as LTV:CAC and for empowering cross-functional leaders with past, present and future performance insights. When built properly, dashboards can also tell compelling stories with your data and make it easy for leaders to visualize how LTV and CAC affect each other. 

According to this survey from the Association for Financial Professionals, data management and predictive analytics are the most important skills that FP&A teams need today. But the same survey also found that inadequate software systems are their biggest roadblock.

So, if you want to create effective dashboards for LTV and CAC—or any other complex metric for that matter—you’ll need to take an honest look at the tools you have in place and evaluate whether or not you can actually perform the strategic analysis that’s expected of you. This represents yet another opportunity to level-up your finance team by complementing your planning processes with data visualization.

LTV and CAC Made Easy With a Complete Planning Solution Built for SaaS

The importance of actively measuring LTV and CAC cannot be overstated for finance teams in SaaS. Proactively analyzing these metrics leads to more strategic decision-making, meaningful collaboration between departments and easier, more data-driven planning processes.

So, if you’re ready to empower your finance team with the tools they need to succeed, check out the link below to see how Vena makes tracking your most important SaaS metrics simple—all without replacing Excel.

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