Calculating the CAC Payback Period
The CAC Payback Period looks at how a business needs to recover its investment in attracting new customers. It is especially crucial for companies that are in industries with large marketing and sales costs. It’s an important metric because it helps businesses measure their performance in a number of ways.
First, it shows how well a business is managing its budget. Based on the resulting figure of the CAC Payback Period, the shorter the time required to break even on its customer acquisition costs, the more efficient a company is with its sales and marketing expenses. If, however, the result is high, this signals the company is doing something wrong and needs to analyze its current approach.
Running this analysis can also identify a company’s financial perils. The more prolonged the CAC Payback Period, the more likely a company might be facing cash flow concerns. Whether it is caused by overall economic conditions or industry or company-specific challenges, this is another reason for a company to run the numbers to see how it can mitigate or turn around the costs associated with acquiring customers.
The calculation also can help a business determine if it is able to expand to new products and markets and scale up existing product lines. The shorter the time needed to acquire new customers, the more likely a business can grow.
When investors and lenders analyze a company’s financials, including this metric, the more efficient a company is, and the more likely it will attract investors or have lenders offer favorable financing terms.
How to Calculate the CAC Payback Period
This scenario looks at $300,000 in customer acquisition costs, such as marketing, sales, etc., for a three-month period. The company obtained 1,000 new customers and is expected to gain $200,000 in new monthly recurring revenue (MRR), with an estimated gross margin of 60 percent.
First Step: Calculate the CAC by dividing Sales and Marketing Expenses by the new customers (1,000). It’s expressed as follows:
CAC = Sales and Marketing Expenses/Number of New Customers
CAC = $300,000/1,000 = $300 per customer
Second Step: This is to determine the monthly recurring revenue (MRR) per customer. The new MRR amount is divided by the number of newly acquired customers. It’s calculated as follows:
MRR = $200,000/1,000 = $200 per customer
Third Step: Determine the gross margin or how much remains from revenue after subtracting direct costs. In this case, we’ll use 60 percent.
Fourth (and Final) Step: This step determines how many months it will take to recoup the customer acquisition costs from the profits generated by the newly acquired customer. It’s calculated as follows:
CAC Payback Period = $300/($200 x 0.60) = 2.5
Based on the resulting 2.5 figure, it takes, on average, 2.5 months of profit from the newly acquired customers to pay for the customer’s acquisition cost.
Understanding CAC Payback Period Efficiency
If it’s less than 12 months, it’s favorable. This implies a business has an efficient approach to profitability and growth. However, it’s not a hard and fast rule because the repayment time frame can fluctuate based on the economy and the business operations. If a company is a low-margin business or industry (e-commerce, groceries, etc.), a far tighter payback time frame would be necessary to be viable.
There are many factors that can affect this company-specific measurement, such as the industry or sector, current economic conditions, or the business’ approach to gaining new customers. If a company has a shorter CAC Payback Period in an industry that has a generally accepted longer one, this can imply that the company is more efficient in its operations.
This metric is another tool in a financial analyst’s toolbox that can measure and identify efficiency (or lack thereof) and help put businesses back on track for greater financial health.
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