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Calculating Your Ad Budget
Before you pour money into advertising, figure out exactly how much you
should spend.
Q: I've never really done much advertising for my business; I've always
relied on networking and word-of-mouth. Now I'd like to launch a small
campaign, but I'm frightened it will cost a lot of money. How can I figure
out where to start?
A: The first thing you must do is calculate your minimum and maximum
allowable ad budgets:
* Step 1: Take 10 percent and 12 percent of your projected annual, gross sales
and multiply each by the markup made on your average transaction. In this first
step, it's important to remember that we're talking about gross markup here,
not margin. Markup is gross profit above cost, expressed as a percentage of cost.
Margin is gross profit expressed as a percentage of the selling price. Sell an
item for $150 when it only costs you $100, and your markup is 50 percent. Your
margin, however, is only 33.3 percent. This is because the same $50 gross profit
represents 50 percent of your cost (markup,) but only 33.3 percent of the selling
price (margin.) Most retail stores in America (carpet, jewelry and so on) operate
on an average markup of approximately 100 percent, some operate on as little
as 50 percent markup and others add as much as 200. More expensive items, such
as cars, recreational vehicles and houses, typically carry a markup of only 10
to 15 percent.
* Step 2: Deduct your annual cost of occupancy (rent) from the adjusted 10 percent
of sales number and the adjusted 12 percent number.
* Step 3: The remaining balances represent your minimum and maximum allowable
ad budgets for the year. At this point in the calculation, you may learn that
you've already spent your ad budget on expensive rent, or you might also learn
that you should be doing a lot more advertising than you had previously suspected.
Now let's calculate an ad budget. Assume that my business is projected to do
$1 million in sales this year, I have a profit margin of 48 percent, and my rent
is $36,000 per year. The first thing to do is calculate 10 percent of sales and
12 percent of sales ($100,000 and $120,000, respectively).
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Second, we must convert my 48 percent profit margin into markup, because markup
is what we've got to have to make this formula work. Most business owners know
their margin by heart, but never their markup. To make the conversion from margin
to markup, simply divide gross profits by cost. Dividing $480,000 (gross profits)
by $520,000 (hard cost) shows us that a 48 percent margin represents a markup
of 92.3 percent. Bingo.
Now we multiply $100,000 times 92.3 percent to see that our adjusted low budget
for total cost of exposure is $92,300. Likewise, we multiply $120,000 times 92.3
percent to get an adjusted high budget for total cost of exposure of $110,760.
From each of these two budgets, we must now deduct our $36,000 rent. This leaves
us with a correctly calculated ad budget that ranges from $56,300 on the low
side to a maximum of $74,760 on the high side.
Most advertising salespeople will tell you that "5 to 7 percent of gross
sales" is the correct amount to budget for advertising, but don't you believe
it. It simply isn't possible to designate a percentage of gross sales for advertising
without taking into consideration the markup on your average sale and your rent.
Yes, expensive rent for a high-visibility location is often the best advertising
your money can buy, since a business with a good sign in a high-visibility location
will need to advertise significantly less than a similar business in an affordable
location. To prove this, just look at the example above and change the rent to
$75,000 per year. In this case, the ad budget would range from $17,300 to $35,760,
representing just 1.7 to 3.5 percent of sales. The formula I've given you is
the only one that reconciles your ad budget with your rent as well as the profitability
of your average sale. Good luck!
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