How do companies determine if they're actually earning enough money from their customers? 🤔

SaaS companies use a ratio called LTV:CAC 🔢

Lifetime Value (LTV) measures the total gross profit a company will ever make from an average customer. 💰

💡Gross profit = revenue - Cost of Goods Sold

For example, if Nike sells me $1,000 worth of shoes over my lifetime but it cost them $300 to produce those shoes, my LTV to Nike would be $700 ($1000 revenue - $300 COGS) 👟

Customer Acquisition Cost (CAC) is the cost that companies incur to gain one new customer, like advertising and sales expenses. 💸

If a company pays $1,000 for a TV ad, and they get 10 new customers from that TV ad, the CAC for those customers is $1,000 ➗ 10 = $100

Remember: CAC is different from COGS!

COGS is the direct cost for a company to provide a product or service to a customer, whereas CAC is the cost of getting one new customer.

The LTV:CAC ratio compares the lifetime value of a customer to the cost of acquiring them. ⚖️

Companies hope that they’ll eventually make more money from the customer than it costs to acquire them, so if the LTV is greater than the CAC, that indicates a return on investment.

An ideal, healthy LTV:CAC ratio for SaaS companies is typically anything over 3:1, meaning the customer's total value (gross profit) to the company is at least 3x the cost to acquire them. ✅

As an investor, try to look for SaaS companies with a strong LTV:CAC ratio of 3:1 or higher, as it suggests efficient customer acquisition and value 💪