you have to know what I'm about to show you if you want to make money from Facebook ads no matter what business you are in most Facebook advertisers don't know this and I don't want that to be you I'm talking about a very specific metric called LTG to CAC ratio and that might sound quite complicated a lot of business owners find this quite complicated but I'm going to show you exactly how to calculate it for your business I'm going to walk you through it step by step you absolutely need to know what it is you absolutely need to be working on improving it because it's one of the most important things that's going to determine the success of your business it's going to determin the success of your Facebook and Instagram ad campaigns and I'm also going to end the video by talking about ways that you can actually improve it so make sure you stick around to them now to make this as easy and straightforward as possible easy to understand as possible um I've got a spreadsheet here and we're going to go through the entire process don't be intimidated by this the mass we're going to do is very very straightforward we're calculating this metric right LT GP to CAC ratio there's two component parts we'll break those down we'll start with the LG LT GP um first um which refers to Lifetime gross profit so what we're looking to calculate here is how much gross profit do we generate from each customer on average over their lifetime interactions with our business um and there are a number of different metrics that we need to to input in order to to reach this number so the first one is average order value and this can work if you're a product business service business Whatever by the way average order value so how much on average do people um usually pay to your business for your products and services in one go okay so this could be average order value of say uh if someone's purched through a Shopify store what's their average checkout value Shopify will give you that number or if it's a service how much does someone pay on average to your business is it $2,000 a month is it $500 is it whatever now sometimes when I ask business owners what's your average order value which I do all the time one of the most important things that I need to know if I'm giving advice to a business um they will say well it really depends sometimes people spend a tiny amount sometimes they spend lots that's fine that's why we're after an average right it doesn't matter if something times on your store someone checks out for $10 and someone checks out for $5,000 we're after an average okay so you're entering your average let's we're going to give an example business here let's say that the average order value of this example business is $125 the next thing we need to work out is how many times on average does someone purchase from your business now the reason why I've got average number of purchase SL months in here is because if you're on a a subscription type basis you're a software business you're a gym um you're a marketing agency that works on a retainer the number of purchases is going to be how many months they stick around for okay average number of purchases let's say in this example this V is doing quite a good job of of reactivating existing customers and the average person buys six times during their lifetime okay then we simply multiply those two numbers together to get our lifetime Revenue per customer right so we are just doing 125 um time 6 which gives us a lifetime Revenue per customer of $750 on average the average customer the first first purchase of a business will go on to spend $750 with us right the next thing we need to calculate is our gross profit margin so out of that 750 how much of that is cost of goods and direct cost now with physical product businesses this is often really easy to calculate because it's just going to be your cost of good sold right it's going to be the cost from the manufacturer for the product so let's assume that that's what we're operating with here and we're operating with a 50% gross profit margin again this is going to be an average if you've got lots of different products there are different margins you're going to have to work out what the average is um across the board but let's assume it's a 50% uh gross profit margin so that means that for every $100 that a customer spends with us $50 of that is the direct cost what's going to basically go to the manufacture for the products that we are selling okay now that gives us a lifetime gross profit we just times these numbers together again so we times that 750 uh by 50% and that gives us 375 so our lifetime gross profit per customer on average for this example business is $375 a really really important metric now to calculate your gross profit margin how much on average of each sale is going to direct cost for a service based business is quite a bit more difficult so I'm just going to quickly walk through that as an aside we're going to carry on with this example as we go through this this setup here but I know there'll be service businesses watching this that'll need a walk through on that okay so what we effectively need to do is proportion the costs um the salary cost of an employee to the revenue that is responsible for the for the clients that it's delivering for in the case of a service based business okay so this might sound kind of complicated but don't worry it'll become very clear in just a second right so let's say that one employee costs us £3,000 uh per month and again this could be an average right now the revenue per client um that this employee is responsible for delivering for they're providing the service for um let's say that's £2,000 per month right but that one employee um can handle six clients let's say at any one time so Revenue per employee is going to be six times 2,000 12,000 so basically that one employee that cost us £3,000 a month is responsible for delivering for clients that bring in £12,000 per month so our cost of goods sold or in this case really it's direct cost but we can use that um terminology because uh I think more people understand that is simply um the 3,000 divided by the 12,000 and we can change that to a percentage which is 25% right so our cost of goods sold or direct cost is 25% now that means that our gross profit margin is the inverse of that right because if we're only giving 25% of what we're bringing in to the employee or that's the cost then we're left with 75% as a business so our gross profit margin 75% so if you just do one minor and then your cost could sold you get 75% so then for this service based business we would want to come up here and pop in 75% as the margin and then we would go on and make our calculations so if you're service business and it's a little bit more difficult to work out your cost of goods sold and your direct costs to work out your gross profit then just run this calculation down here as we did and that's how you can calculate that number and carry on WE however are going to switch back to the first example for the rest of this process um so I'm going to change that back to 50% so all the numbers makes sense okay so going back to this example now we've got $375 lifetime gross profit per customer that's a really really important good metric to know now what a lot of businesses get this wrong is they look at lifetime Revenue per customer but that doesn't factor in margin so we could have a couple of different businesses let's say business a business B they both generate $750 per uh customer when it comes to Lifetime Revenue but if business a has a 10% gross profit margin that means that only $75 of that is gross profit whereas if business B has a 90% gross profit margin then that means that $675 of that is gross profit so when you're working out the viability of running campaigns of generating customers the profitability of your business those two numbers $75 gross profit versus $675 gross profit is absolutely enormous the difference there and that's why you need to take the extra step work out your average gross profit margin and then work out lifetime gross profit per customer now a lot of platforms like Shopify for example will calculate this life time gross profit figure for you make it uh nice and straightforward you just look at your dashboard and and there it is or you can do a little bit of digging and find it um in analytics but if you don't have that or perhaps you're running on a platform like Shopify but doesn't have all the data you've got some purchase coming in from elsewhere you're going to need to calculate this manually as we've just seen it's not that difficult to do it doesn't take that long but it is one of the most important metrics to be aware of for the viability of your business the profitability of your ad campaigns and knowing what you can do going forward and something you want to track cuz you want to improve it as we're discuss um later on in the video now I do want to address that there'll be some people that won't have enough data to work this out accurately yet if that's the case then you're just going to need to estimate at this point if it's wildly inaccurate that's fine it's better than nothing you can then always amend this um as time goes on and this is this is a moving number anyway so for example if you just started running ads perhaps you do know what your average order value is something we always want to try and improve but perhaps you do know it but you don't know how many times on average someone purchases from you over your lifetime because you've only running ads for a couple months fair enough it might be six it might be 12 it might be two again that's something we're going to actively work on because we want to reactivate old customers and try and get them to buy again and again and again because that increases the lifetime Revenue it increases the lifetime um gross profit which as we now know is really really important but I just wanted to quickly address that that just guess for now and once you start to get that data you can always um update it later on and that's going to to help you when it comes to not knowing how many times on average a customer is going to purchase from you over their lifetime you're probably going to underestimate if you're relatively new business and it's much better to do it that way round than overestimate you're much better to go Oh in 2 years time our business is much more profitable than we thought because we thought people would buy three times from us and they actually buy Six Happy Days we make twice as much money per customer as we thought we were going to do much better that way round than the other way around so I just wanted to uh to quickly address that okay now we need to talk about CAC the other part of this right so cost to acquire a customer is what that stands for and it's much much easier to calculate okay so let's assume that you're already running ads this is the mask we go through so let's say in the last 30 days I spent $5,000 on ad spend and then we generated hundred new customers now it's very important that we look at new customers here we're not looking at say your total customer base and how many are now there after that month of advertising no we spent the 5,000 during this period how many did we generate new during this period let's say it's 100 so then we very simply just divide our total ad spend by new customers Acquired and we get 50 so we're looking at $50 to acquire a new customer um in this scenario and you can do different time frames on this you could look at over a year if you've got more data absolutely add that in again this is a metric that we're going to want to improve and that's often what we're trying to do as Facebook and Instagram advertisers we're trying to reduce our cost to acquire a customer how can we get our cost for purchase in this case down from $50 to $40 to 30 etc etc um but just make sure that those two numbers match up right so you're looking at the ad spend and the new customers acquired in the same time period okay so now we need to put these two numbers together um as a ratio and I've added some more information to make it super super clear right so our lifetime gross profit per customer is 375 we've we know that we've calculated it our cost to acquire a customer is $50 okay and then we just very simply to calculate this as a ratio is just ltp uh divided by our cost to acquire a customer which is going to come out at 7. 5 or displayed as a ratio would be like this right it be 7. 5 um to one that's our lgp to CAC ratio now what that means is that for every dollar that we're spending on ads we are generating $7.
50 in gross profit which is fantastic that's a really really good number what we're aiming for when it comes to targets here is anything really above a three and you might be thinking why why not a two why wouldn't two work surely $1 in $2 back is great that's because out of that gross profit you've got to pay for everything else you've got to pay for your overheads and insures and admin staff and all that sort of stuff and those costs really really increase as you scale a business and this metric really wants to be as high as possible I mean we've worked with clients that operate with a a 12:1 with a 20 to1 one that even operated with a 60:1 LTG to C rati which is absolutely fantastic it means you're effectively printing money when you're running um ad campaigns now I'm going to show you how to improve your LTG to ca ratio in a second before I do just want to quickly let you know about our done for you Facebook and Instagram advertising Services we can create manage and optimize your Facebook and Instagram ad campaigns for for you take that workload off your hand hopefully help you get much better results calculate all these sorts of things and and hopefully help improve those metrics so we can get your business heading in the right direction and scaling if that's something you might be interested in there is a link in the video description below go ahead and click on that come through to a page and a website you can book in a free call with one of my team members to find out more hopefully we get a chance to work together now before we get into how to improve your LTG to CAC ratio I want to quickly note something and that's that in this scenario we're spending a dollar to make $750 in gross profit but we aren't receiving that straight away so this ratio is different to return on ad spend I can imagine people being like why don't you just look on return on and spend remember that that $750 per customer of Revenue you're generating that's over six separate purchases so if you're looking at acquiring the customer that's going to show up as $50 cost in your ad account but your first initial transaction is only for $125 so your average transaction your average return on ad spend in that short term is going to be $50 out $125 in which is a 2. 5 return on ad spend so you might might made these calculations and think why am I looking at a 7. 5 LTG to CAC ratio but I'm only seeing a 2.
