LTV Formula Explained: How to Calculate Customer Lifetime Value

When to use each formula variation

Depending on your operational framework, customer relationships might be structured as recurring contracts or transactional checkouts. Using the correct formula is essential to avoid forecasting errors.

1. Transactional Models (Retail, DTC E-commerce)

In transactional models, customers buy items irregularly. You calculate ARPU by multiplying Average Order Value (AOV) by Purchase Frequency. The customer lifespan is typically estimated from historical repeat purchase drop-off metrics.

2. Contractual Models (B2B SaaS, Subscription Boxes)

For subscription plans, the customer lifespan is mathematically defined by your churn rate. Since Lifespan is equal to 1 / Monthly Churn %, you can calculate the LTV by dividing monthly ARPU (or MRR) by the churn rate.

Worked Example Calculation

Let’s calculate a gross-margin-adjusted subscription contract. A company charge $80 per month for a subscription, has direct hosting/support costs of 20% (yielding an 80% gross margin), and records a monthly customer churn rate of 5%.

Common LTV Mistakes to Avoid

• Using Revenue instead of Margin: Forgetting to multiply by Gross Margin % yields inflated LTV values, which leads to overspending on CAC.
• Ignoring Cohorts: Treating all customers as a single average hides variations between small accounts and enterprise clients.
• Underestimating Churn: Small increases in monthly churn dramatically contract the customer lifespan and collapse your LTV.