The CAC Payback Period and Debt
Debt takes on many forms within a company. It could be a bond or a traditional long-term bank loan. Typically, there is a principal balance that you repay over time along with some type of interest component. In this post, I detail how I calculate the CAC Payback Period and how to understand its impact on your SaaS business.
What if I were to say that Customer Acquisition Costs (CAC) were just another form of corporate debt with a twist? You have a balance or principal amount, the amount spent to acquire a new customer, and an interest component. In this case, the interest is the opportunity cost of monies tied up in CAC that could have been spent elsewhere (for example, new product).
Google “cac ltv” and you return about 237,000 results. Google “CAC Payback Period” and you return “only” 15,800 results. Fewer results but the CAC Payback Period is getting more attention these days and much deserved.
Download the CAC Payback Period Excel template below.
CAC Payback Period Definition
In my view, the CAC Payback Period is the number of months required to pay back the upfront customer acquisition costs after accounting for the variable expenses to service that customer. Simply put, CAC Payback Period equals CAC divided by the gross margin dollars generated by that customer.
I also would like to note an alternative denominator input. This can also be MRR * Recurring Gross Margin % rather than ACS.
Inputs Required
There are only three inputs required for this formula which makes it an easy calculation and easily understood.
CAC = average customer acquisition cost
MRR = average monthly recurring revenue
ACS = average cost of service
If you are not familiar with the formulae for CAC and ACS, click on the links above to review the posts detailing how to calculate these metrics. My Excel models are also available for download for these metrics.
Step 1 – Calculate the CAC (Customer Acquisition Cost)
If you have not calculated CAC previously, I explain how to calculate CAC here.
Step 2 – Calculate the CAC Payback Period
To calculate the payback period, you need:
CAC, MRR, and ACS (or MRR * GM % of Recurring Revenue)
Since I am using MRR, the formula will calculate the number of months required to pay back the upfront customer acquisition costs.
Important Assumptions
The payback period does not factor in churn or the time value of money. Why is churn important? Think of the payback period like debt repayments as mentioned above. You have a stream of income (MRR – ACS) paying off a portion of the total CAC (i.e. debt) each month. If you lose that stream of income (i.e. customer), you still have to make payments on your debt.
This is the hidden cost of churn. Now, your next customer or customers must pay off their own acquisition costs and the acquisition costs of customers who have churned (assuming you didn’t pay off CAC yet). Even though you might have a nice customer acquisition rate, you are getting deeper into debt with each churned customer.
The more churn you have, the longer it will take your SaaS business to reach a revenue level where you are covering both acquisition costs and service costs (ACS). And remember, you still have other costs to cover (G&A, products) below the gross margin level that determine your overall net profitability.
Time Value of Money
Another factor is the time value of money. The formula above does not account for the fact that you are paying off CAC over time. A dollar in the future is worth less than a dollar today.
In my example, the payback period was 14.8 months. Introduce a 15% WACC and your payback period is three months longer. This is important for those who have longer payback periods. Not only do you have the “debt” payments, but you also have interest, or opportunity costs, on that money.
Summary
CAC Payback Period is receiving much deserved attention. As traditional debt can steal away our free cash flow, so can your CAC debt. With a few key inputs, you’ll better understand the long-term economics of your SaaS business.
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I have worked in finance and accounting for 25+ years. I’ve been a SaaS CFO for 9+ years and began my career in the FP&A function. I hold an active Tennessee CPA license and earned my undergraduate degree from the University of Colorado at Boulder and MBA from the University of Iowa. I offer coaching, fractional CFO services, and SaaS finance courses.
[…] are your margins not increasing as expected. Have you calculated your CAC or CAC Payback Period or your Average Cost of Service? If these metrics are out of alignment, your margins could be […]