Why and How to Calculate LTV for SaaS

One of the technical aspects of running an SaaS business, or really any service-based industry, that seems to really scare people away is how to calculate LTV. We all remember our time in school, and the various forms of awkward math that we had drilled into us against our will. And at the time, we thought “I only need to know how to count money, or work simple algebra because I’m going to write software, or run a business that does, darn it”. Well, maybe we didn’t think of it quite that way, but we refused to believe our instructors when they said we’d need this math someday.

Lo and behold, we need that math someday. We didn’t know that long division and ratios were teaching us how to calculate LTV, heck we didn’t even know what an LTV was at the time more likely than not. But, here we sit, needing metrics only this math can actually produce.

Take heart, though, because this is one of the easier metrics to calculate, unlike things such as ACV, so as long as you’re ok with decimal numbers, division, conversion to percentages and calculating rates, then this isn’t so bad. Also, now that we have phones as powerful as old super computers in our pockets, we needn’t even worry about doing the math ourselves, we need only know what math to have those perform!

So, in order to calculate LTV, you need to have a couple metrics ahead of time, neither of which you are likely to not already have. First, you need to know what your churn rate is over the time increment you’re going to measure. Second, you need to know your ARPA. You probably already know what your ARPA is, but if you didn’t, it’s your average MRR per account. And your MRR, if you didn’t know, is your monthly returning revenue per new account. But, those are basic metrics you learned about your first day in business school, so let’s talk about the other metric you need to complete the simple equation for calculating your LTV.

Since LTV is your customer lifetime value, you need to calculate what a customer lifetime is. That’s simple. Simply divide 1 by the customer churn rate. You can convert this to a percentage if you just want your lifetime unit for other purposes (where it is percentage of a fiscal time window), but for this, let’s leave it as the ugly little decimal it is.

Now, we have our lifetime, we know our ARPA, and we know our churn rate. So all we need to do is to plug these into a simple math problem to get our LTV. We can express it as either LTTV = ARPA/Customer Churn Rate, or we can express it as LTV = ARPA * Customer Lifetime. Either approach should return more or less the same number, once you do some rounding.

That’s really all there is to this. The complexity is just in knowing what metrics to have first, and calculating one of them you may not have handy beforehand, that being the customer lifetime as a unit metric to plug in. Once you have these, it’s really just a problem you could have solved in high school

So, that’s how to calculate LTV, and I hope I, from one non-math wizard to another, have shown that there’s really nothing to fear when it comes time to get metrics like this. They’re usually pretty simple, and just present themselves as unworldly complex because of lots of abbreviations and inherited metrics to make them work.

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Omri Erel
Omri is the Head of Demand Generation, as well as the Lead Author & Editor of the SaaSAddict Blog. Omri established the SaaSAddict blog to create a source for news and discussion about some of the issues, challenges, news, and ideas relating to SaaS and cloud migration.
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