Customer Lifetime Value (LTV) Calculations

Q: I have a SaaS business plan and was curious how your model calculates the Customer Lifetime Value (LTV)?

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A: We have very comprehensive CLTV calculations. Rather than simply modeling an overall CLTV for all customers and offering types (which is not particularly useful or insightful), our model includes all of the LTV calcs for each offering type to really show clarity. For example, if your offerings include selling a mix of one-time offerings, freemium offerings, standard offerings, and premium offerings, you will want to follow and track the LTV calcs for all offering/customer types to compare and contrast to help you really fine-tune your model. You can ungroup and scroll across month-by-month, quarter-by-quarter, and year-by-year in the Sales detail report to see how the LTV calcs change over time based upon your inputs. This is what both entrepreneurs and investors really want to see: the specific LTVs by specific offerings to be able to pressure test the assumptions in the plan.

The Startup Financial Model meticulously calculates all sales, marketing, and account management expenses from lead generation expenses, to sales commissions expenses, to account management expenses for each offering, along with all of the other direct costs from COGS, Direct Labor, etc. Also, note that the LTV calcs include all sales and account management-related expenses, including an allocation of general sales and marketing expenses to fully capture the total expenses.

Here’s the simple version of what goes into the calculation in our model rather than drag you through all of the calculations:

  • The length of relationship
  • The renewal rate (opposite of churn rate)
  • The revenue and the impact of any price increases over time
  • The direct expenses, including all COGS/COS, direct account management/support expenses, allocated other direct expenses, and your allocated direct marketing expenses for retention and the impact of any expense and salary increases over time
  • The resulting contribution margin, which may vary over time based on any changes over time as noted above
  • The cost of customer acquisition, including all sales-related expenses, lead generation expenses, revenue share expenses, and your allocated direct marketing expenses for acquisition, including all changes over time
  • The waterfall effect of earlier customers being acquired and served at potentially different contribution margins than later customers
  • Your discount factor

The discount rate is applied over the Life of the customer, so a one-time sale, which has no "Life" beyond just one month, is delivered and paid within just one month has an extremely short life so only 1/12th of the annual discount rate applies, therefore the residual LTV is just over 99% of the 100% of non-discounted value. So, net, net, you experience hardly any discounted effect. (Think of the value on the NPV Discount Rate row as the residual, or (100% - the applicable discount rate) for the period specified after the length of relationship and renewal rates are applied to form the calculation of the length of Life.)

In a similar fashion, for a recurring sales model, after everything listed above is taken into account, the model calculates the proper residual amount after the discount has been applied over the entire contribution margin stream over the expected life of the customer, less total acquisition expenses. So a five-year relationship is discounted heavily in the later years due to your discount rate, sort of like the opposite of compound interest.