How to calculate customer lifetime value
Customer lifetime value (LTV, sometimes CLV) is the gross profit you expect from an average customer before they cancel. For a subscription product the standard formula is:
LTV = average monthly revenue per customer x gross margin / monthly churn rate
The churn part works because 1 divided by monthly churn is the average customer lifetime in months. Lose 4% of customers a month and the average customer stays 25 months. Lose 10% and they stay 10.
A worked example
| Input | Value |
|---|---|
| Average revenue per customer | $49 a month |
| Gross margin | 80%, so $39.20 of gross profit a month |
| Monthly churn | 4%, so a 25-month average lifetime |
| LTV | $39.20 x 25 = $980 |
What to count in gross margin
Gross margin is revenue minus the cost of serving customers. For a typical SaaS product that means hosting and infrastructure, third-party APIs and AI model costs that scale with usage, payment processing fees, and customer support time. It does not include marketing, product development, or your own salary, which are operating costs.
Software margins of 70% to 85% are common. Products with heavy AI usage, human onboarding, or marketplace payouts often run far lower, which cuts LTV sharply. Use your real number rather than a benchmark.
What is a good LTV to CAC ratio?
LTV only becomes useful next to customer acquisition cost (CAC): everything you spent on sales and marketing in a period divided by the new customers it produced.
- Below 1 : 1. Each customer costs more than they return. Fix pricing, churn, or the channel before spending more.
- 1 : 1 to 3 : 1. Profitable per customer but thin. Common early on.
- Around 3 : 1. The usual SaaS target, leaving room for overheads.
- Well above 5 : 1. Often a sign you could spend more on growth.
CAC payback, the months of gross profit needed to earn back acquisition cost, matters just as much for a bootstrapped founder. A great ratio with a 30-month payback can still run you out of cash.
Why LTV is often wrong for new products
The formula is simple. The inputs are not. Three mistakes show up again and again in early-stage numbers:
- Churn from a tiny sample. Two cancellations out of 40 customers is 5% one month and 0% the next. Average several months before trusting it.
- Early cohorts that differ from later ones. Your first users are often friends and fans who churn less than strangers from ads.
- Uncapped lifetime. 1% monthly churn implies customers stay over eight years. Cap lifetime at three to five years until you have the history to prove more.
How to raise LTV
- Reduce churn first. It has the largest effect because it divides the whole equation. Cutting churn from 5% to 4% raises LTV by 25%.
- Offer annual plans. They lock in a year and usually churn less.
- Add expansion revenue. Seats, usage tiers, and add-ons let revenue per customer grow over time.
- Test pricing. Many early products are underpriced, and a price change moves LTV directly.
Measure churn properly with the churn rate calculator, and see which channels bring customers worth acquiring in which marketing channel actually makes you money.
Frequently asked questions
- How do you calculate LTV?
- Multiply average monthly revenue per customer by gross margin, then divide by monthly churn. A $49 plan at 80% margin with 4% monthly churn gives $39.20 of gross profit a month for 25 months, an LTV of $980.
- What is a good LTV to CAC ratio?
- A common SaaS benchmark is 3 to 1: each customer returns three times what it cost to acquire them. Below 1 to 1 you lose money on every customer. Far above 5 to 1 can mean you are underinvesting in growth.
- Should LTV use revenue or gross profit?
- Gross profit. Revenue-based LTV ignores the hosting, payment fees, and support each customer costs, so it overstates what you can afford to spend on acquisition.
- Why cap customer lifetime?
- At very low churn the formula predicts customers staying for decades. A young product has not existed long enough to prove that, so capping lifetime at three to five years keeps the number honest.
- How do I calculate LTV with annual plans?
- Divide the annual price by 12 for monthly revenue, and use the monthly equivalent of churn. If 20% of annual customers do not renew, that is roughly 1.8% a month.