What do an indie hacker and a mature venture capitalist running a SaaS business have in common?
They both dream of making passive income, but one dreams in code and the other in commas!
Yes, I know, this is a terrible ChatGPT joke.
But actually, they both care about their custom lifetime value (LTV). LTV is one of those metrics that can tell a lot about your business health and product.
But how do you calculate LTV?
First, you need a few business data, which you then plug into our SaaS lifetime value calculator.
SaaS Lifetime Value Definition
The SaaS Lifetime Value (LTV) estimates the total revenue you can expect from a customer over their entire relationship with your company.
Generally, understanding your LTV helps in strategic decision-making. You can:
- Optimize marketing budgets
- Improve customer retention strategies
- Enhance product features based on revenue forecasts
A higher LTV means more revenue and lower acquisition costs over time.
SaaS Lifetime Value Formula
There are several methods to calculate LTV, but a commonly used formula in the SaaS industry is:
LTV = (Average Revenue per Account (ARPA) × Gross Margin) / Churn RateWhere:
- ARPA (Average Revenue per Account): The average monthly or annual revenue generated per customer account.
- Gross Margin: This is the percentage of revenue that exceeds the cost of goods sold (COGS). It represents the profitability of the revenue.
- Churn Rate: This is the rate at which customers cancel their subscriptions or stop using the service. It is usually expressed as a monthly or annual percentage.
To enhance precision, also consider:
- CAC (Customer Acquisition Cost): Subtract this from LTV for net value.
- Expansion Revenue: Extra revenue from upsells or cross-sells.
Adjusting based on specifics like these improves accuracy.
When you calculate the LTV of your business, there are also some challenges to keep in mind.
- Accuracy of Input Data: Accurate calculation of ARPA, gross margin, and churn rate is essential. Any errors or misestimations can significantly impact the LTV calculation.
- Changing Dynamics: SaaS businesses can experience fluctuations in churn rates, ARPA, and gross margins due to market conditions, competitive actions, and internal changes. So make sure you regularly monitor and adjust the LTV calculation.
SaaS Lifetime Value Example Calculation
Imagine you have a SaaS product with the following metrics:
- Monthly revenue from all customers: $100,000
- Number of customers: 1,000
- Customer canceling their subscription: 50 monthly
- COGS (Cost of goods sold): $30,000
Having that information, we can start calculating our LTV.
First, we need to determine ARPA:
If the total monthly revenue from all customers is $100,000 and there are 1,000 customer accounts, then:
ARPA = $100,000 / 1,000 = $100Then, we calculate the gross margin:
Gross Margin = (Revenue − COGS) / Revenue × 100
Gross Margin = ($100,000 − $30,000) / 100,000 × 100 = 70%Moving on to the churn rate:
If 50 out of 1,000 customers cancel their subscriptions in a month, then:
Monthly Churn Rate = (50 / 1,000) × 100 = 5%Now that we have all the variables, we can calculate LTV:
Using the LTV formula, plug in the ARPA, gross margin, and churn rate:
LTV = ($100 × 0.70) / 0.05 = 70 / 0.05 = $1,400This means the expected lifetime value of a customer is $1,400.