How to calculate Life Time Value (LTV) of your customers correctly

Life time value (LTV) of customers is one of the key metric measured by startups to offset a heavy one time customer acquisition cost. In simpler terms, it is the approximate value (in money terms) a customer could deliver through their lifetime on your product. This helps startups (consumer or SAAS) in allocating the budgets for customer acquisition (CAC). Ideally CAC should never be higher than LTV unless you are yet to unlock the full revenue potential of your product.

Also, it is important to calculate LTV when you have seen few cycles of acquisition, churn & monetisation. Calculating too early in your journey is going to give misleading results.

You may find 100s of search results with LTV formulas when you google it, but to my surprise 90% of those results gave a formula which may not accurately calculate LTV for your startup.

The most common formula you will see is:

ARPU = Average Revenue Per User (Total Revenue during the period/Customers during the period)

Churn = 1- Retention%
Retention % = Customers who repeat during the period.

Here is the safest way to calculate customer retention:

Select period based on your product’s frequency. It could be daily/weekly/monthly OR the subscription period of your product which could be upto a year.

But the formula of LTV shown above is misleading and is vanity at best

Here is the right way to calculate your real LTV:

The real value from a customer can only be derived if you reduce all the expenditure you made on serving this customer. This could include cost of goods sold or any direct charges like payment fee/MDR, manpower cost (if required to close a deal always) or any cost which can be attributed to the customer. This will not include marketing cost, incentives, cashbacks, freebies as that would go into calculating your customer acquisition cost.

Once you have LTV and CAC then you can divide LTV by CAC and ensure it is greater than 1 before you increase your marketing spends. All high growth companies have LTV/CAC ratio of 5 & above.

Hope you will be able to calculate your LTV the right way from now on. It may look radically different from the basic LTV formula but that’s the ONLY way to find out the real worth of a customer.

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