When running a small business, understanding your customer acquisition costs (CAC) and customer lifetime value (LTV) is crucial. These two metrics can give you a clear picture of how much you're spending to acquire customers and how much revenue you can expect to make from them over time. Knowing these numbers helps you make better decisions on how to grow your business sustainably.
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What is CAC (Customer Acquisition Cost)?
Customer Acquisition Cost (CAC) is the total amount of money you spend to acquire a new customer. It includes all the costs related to marketing, advertising, and sales efforts aimed at bringing in new customers.
In simple terms, CAC shows how much it costs you to get a single customer. If you know your CAC, you can compare it to how much money that customer will bring in over their lifetime (which is where LTV comes in). Ideally, your CAC should be much lower than the revenue you generate from your customers.
Formula for CAC:
\text{CAC} = \frac{\text{Total Marketing and Sales Costs}}{\text{Number of New Customers Acquired}}
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What is LTV (Customer Lifetime Value)?
Customer Lifetime Value (LTV) is the total revenue you can expect to generate from a customer over the entire time they stay with your business. LTV helps you understand how valuable each customer is over time, which can guide your spending decisions, such as how much you're willing to spend on acquiring new customers (CAC).
LTV takes into account not just the first purchase, but any repeat business from that customer, including upsells, cross-sells, and ongoing purchases.
Formula for LTV:
\text{LTV} = \text{Average Purchase Value} \times \text{Average Purchase Frequency} \times \text{Customer Lifespan}
Where:
Average Purchase Value is how much a customer spends on average per transaction.
Average Purchase Frequency is how often a customer buys from you over a period (e.g., monthly or annually).
Customer Lifespan is the average length of time a customer continues to buy from you.
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Why CAC and LTV Matter
Understanding both CAC and LTV allows you to make smarter business decisions. If you’re spending too much on acquiring customers (high CAC), but those customers aren’t bringing in enough revenue (low LTV), your business might be heading toward an unsustainable path.
On the flip side, if your LTV is significantly higher than your CAC, you’re in a good position. You’re acquiring customers at a low cost and making a lot of money from them over time.
Key points to remember:
If CAC > LTV, you’re losing money on your customers.
If CAC < LTV, you’re generating profit and have room to scale.
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How to Calculate CAC and LTV Using Excel
Now that we know what CAC and LTV are, let’s see how you can calculate them step by step using Excel.
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Step 1: Set Up Your Excel Spreadsheet for CAC
Start by setting up a simple table to track your marketing and sales costs.
To calculate CAC, divide the total marketing and sales expenses by the number of new customers acquired.
Formula for CAC:
=B2/C2
Where B2 is the marketing and sales expenses, and C2 is the number of new customers. Drag the formula down for other months.
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Step 2: Set Up Your Excel Spreadsheet for LTV
Now, let’s calculate LTV. Start by gathering data like the average purchase value, frequency of purchases, and customer lifespan. Here’s an example table:
The LTV is calculated by multiplying the average purchase value, purchase frequency, and customer lifespan.
Formula for LTV:
=B2*C2*D2
Where:
B2 is the average purchase value,
C2 is the average purchase frequency,
D2 is the customer lifespan.
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Step 3: Review Your Data and Make Insights
Once you've filled out your tables, you’ll be able to see the calculated CAC and LTV for each month. Here’s an example of how your spreadsheet might look after calculating everything:
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Step 4: Compare CAC to LTV
The real magic happens when you compare your CAC to LTV:
In January, your CAC is $20 and your LTV is $2,400. This means that for every $1 you spent on acquiring a customer, you earned $120 in revenue. This is a strong ROI.
In February, the CAC stayed the same at $20, but the LTV went up to $2,750, meaning that customers became more valuable, possibly due to higher purchase frequency or better customer retention.
In March, the LTV continued to rise to $3,960, a good sign that your customers are spending more and sticking around longer.
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Interpreting the Results
CAC < LTV: If your CAC is lower than your LTV, you are in a healthy spot, as each customer is worth more to your business than it costs to acquire them. This shows you’re spending efficiently and should consider reinvesting profits into scaling customer acquisition.
CAC > LTV: If your CAC is higher than your LTV, it means you're spending more to acquire customers than you’re making from them. This is a red flag, and you may need to either reduce your customer acquisition costs (e.g., by improving your marketing efficiency) or find ways to increase your customer lifetime value (e.g., by increasing retention or cross-selling).
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Practical Tips for Small Business Owners
1. Track Costs Accurately: Be sure to track all costs associated with acquiring customers, including advertising, marketing staff, sales commissions, and any tools you use. This will give you a more accurate picture of your CAC.
2. Increase LTV: There are several ways to increase customer lifetime value:
Improve Customer Retention: Focus on keeping your customers happy and engaged with your products or services. Happy customers are more likely to return and spend more.
Upselling and Cross-Selling: Offer additional products or services that complement what the customer already buys.
Loyalty Programs: Reward repeat customers with discounts or special offers to keep them coming back.
3. Use Data to Make Decisions: Regularly calculate and review your CAC and LTV to make better decisions about where to invest your time and money. This data is valuable for understanding the effectiveness of your marketing and sales efforts.
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The goal is to ensure that your LTV is higher than your CAC—that way, you’re not only acquiring customers, but also generating sustainable, long-term profits.