How to calculate LTV:CAC for a subscription business
LTV:CAC compares what a customer is worth over their lifetime with what it costs to acquire them. This guide covers the formula, a worked example, payback period, and why 3:1 is the usual target.
MakeSense··3 min read
What LTV:CAC measures
Customer lifetime value (LTV) is the profit a customer contributes over the whole time they stay. Customer acquisition cost (CAC) is everything spent to win that customer. The ratio tells you whether the economics of acquiring customers work.
A ratio below 1:1 means every customer is a net loss. The widely cited healthy floor is 3:1 - enough to fund growth and cushioned against estimates being optimistic.
The LTV formula
LTV = average revenue per user (ARPU) × gross margin ÷ monthly churn rate
Worked example
- ARPU (monthly revenue per customer): Rs. 1,500
- Gross margin: 70%
- Monthly churn: 4%
- CAC: Rs. 6,000
LTV = 1,500 × 0.70 ÷ 0.04 = Rs. 26,250
LTV:CAC = 26,250 ÷ 6,000 = 4.4:1
Payback = CAC ÷ contribution per month = 6,000 ÷ 1,050 = 5.7 months - recovered in under half a year, which comfortably supports reinvesting in acquisition.
Why payback matters as much as the ratio
A great ratio can still starve you of cash if payback is long. Every customer acquired ties up acquisition spend until their contributions recover it. Under 12 months is the usual target for self-funded growth, because cash recovered within a year funds the next cohort of customers.
Common mistakes
- Using revenue instead of gross margin in LTV. Hosting and support costs are real; revenue-only LTV overstates customer worth.
- Understating CAC. Sales salaries and tooling belong in acquisition cost, not just ad spend.
- Assuming churn is constant. Early cohorts usually churn faster than the blended average.
- Chasing a very high ratio. A 10:1 ratio often means you are underspending on growth the market would support.
Step-by-step calculation
- Calculate ARPU
Monthly recurring revenue divided by the number of customers. Exclude one-time setup fees.
- Estimate gross margin
The percentage of revenue left after serving the customer - hosting, support, payment fees, delivery.
- Find monthly churn
Customers lost in a month divided by customers at the start of the month. At 4% churn, the average customer stays about 25 months.
- Compute LTV
ARPU × gross margin ÷ churn. For Rs. 1,500 × 0.70 ÷ 0.04 = Rs. 26,250.
- Compute CAC
All acquisition spend in a period, including sales salaries, divided by new customers won in that period.
- Divide LTV by CAC
The ratio. Also divide CAC by monthly contribution to get the payback period in months.
Frequently asked questions
What is the LTV:CAC formula?
LTV = ARPU × gross margin ÷ monthly churn. LTV:CAC divides that LTV by customer acquisition cost. Example: Rs. 26,250 LTV ÷ Rs. 6,000 CAC = 4.4:1.
Is 3:1 the only good LTV:CAC ratio?
Below 3:1 most businesses struggle to fund growth from their own economics, but far above it can mean underspending on sales. The right number depends on your industry and cash position.
What is a good CAC payback period?
Under 12 months is the typical target for self-funded growth so recovered cash can finance the next cohort. Longer payback can be fine with external capital.
Should LTV use revenue or gross margin?
Gross margin. Revenue-only LTV overstates what a customer is worth because serving them costs money.
How does churn affect LTV?
LTV is inversely proportional to churn: halving monthly churn doubles LTV. It is the single most sensitive input in the formula.