Business owners have long been taught to budget 5 to 6 percent of total sales for advertising and another 5 to 6 percent for rent, or cost of occupancy. This formula, however, often results in underperformance due to too little being spent on advertising. The business owner who spends only 1 or 2 percent of total sales on cost of occupancy is seriously underspending when only 5 to 6 percent is budgeted for advertising.
The purpose of advertising is to increase the exposure of your business beyond what is provided by your physical location. The business owner who saves money by investing in a weak location will have to advertise much more heavily. A high cost of occupancy for a landmark location is often the least expensive advertising your money can buy.
Although there’s no “one size fits all” formula for calculating the correct advertising budget, there is a concise formula for calculating the ad budget for retail businesses, and, in my experience, the formula can be easily adjusted to serve other business categories as well.
The following formula assumes a retail business averaging a 100 percent markup (in other words, a 50 percent gross profit margin.)
Step 1: Budget 10 to 12 percent of total projected sales for total cost of exposure.
Step 2: Adjust this figure by the store’s average markup (above cost of goods sold). If the average markup is 100 percent (“keystone”), then the formula will be unadjusted (10-12 percent of projected sales x 100 percent). If the average markup is only 91 percent, then the adjusted budget for total cost of exposure will be reduced by 9 percent (10-12 percent of projected sales x 91 percent — see?) Likewise, if the average markup is 150 percent, then the adjusted budget for total cost of exposure would be increased by 50 percent (10-12 percent x 150 percent).
Step 3: Deduct your cost of occupancy from your adjusted total cost of exposure. The remaining balance is your ad budget.
NOTE: Please be careful to use MARKUP rather than MARGIN in this calculation. (Markup is gross profit dollars expressed as a percentage of cost-of-goods. Margin is the same gross profit expressed as a percentage of gross sales. Hence, a 100 percent markup yields a 50 percent margin. A 200 percent markup yields a 66.67 percent margin.
MARGIN is Gross Profit Dollars ÷ Gross Sales Volume
MARKUP is Gross Profit Dollars ÷ Cost of Goods
If your having a difficult time understanding why we use this formula and if you want one of our Home Office client consultants to help you calculate your ad budget, give them a call at 512-295-5700. Ask for Sean Taylor who has been trained by the Wizard to help you grow your business.