How to Develop an Effective Advertising Budget

Your journey towards creating effective advertising for your business starts with an advertising budget. Developing your advertising budget - Deciding just how much should be invested in making sales grow - and how that amount should be allocated is completely up to you, the business owner-manager.

Advertising costs are a completely controllable expense. Advertising budgets are the means of determining and controlling this expense and dividing it wisely among departments, lines, or services.

This chapter describes various methods (percentage of sales or profits, unit of sales, objective and task) for intelligently establishing an advertising budget and suggests ways of applying budget amounts to get the effects you want

If you want to build sales, it's almost certain you'll need to advertise. How should you allocate your advertising dollar? How can you be sure your advertising outlays aren't out of line? The advertising budget helps you determine how much you have to spend and helps establish the guidelines for how you're going to spend it.

What you'd like to invest in advertising and what you can afford are seldom the same. Spending too much is obviously an extravagance, but spending too little can be just as bad in terms of lost sales and diminished visibility. Costs must be tied to results. You must be prepared to evaluate your goals and assess your capabilities - a budget will help you do precisely this.

Your budget will help you choose and assess the amount of advertising and its timing. It will also serve as the background for next year's plan.

Methods of Establishing an Advertising Budget

Each of the various ways in which to establish an advertising budget has its problems as well as its benefits. No method is perfect for all types of businesses, nor for that matter is any combination of methods.

Here concepts from several traditional methods of budgeting have been combined into three basic methods:

(1) Percentage of sales or profits

(2) Unit of sales

(3) Objective and task

You'll need to use judgment and caution in settling on any method or methods.

Percentage of Sales or Profits

The most widely used method of establishing an advertising budget is to base it on a percentage of sales. Advertising is as much a business expense as, say, the cost of labor and, thus, should be related to the quantity of goods sold.

The percentage-of-sales method avoids some of the problems that result from using profits as a base. For instance, if profits in a period are low, it might not be the fault of sales or advertising. But if you stick with the same percentage figure, you'll automatically reduce your advertising allotment. There's no way around it: 2% of $10,000 is less than 2% of $15,000. Such a cut in the advertising budget, if profits are down for other reason, may very well lead to further losses in sales and profits. This in turn will lead to further reductions in advertising investment, and so on.

In the short run a business owner might make small additions to profit by cutting advertising expenses, but such a policy could lead to a long term deterioration of the bottom line. By using the percentage-of-sales method, you keep your advertising in a consistent relation to your sales volume - which is what your advertising should be primarily affecting. Gross margin, especially over the long run, should also show an increase, of course, if your advertising outlays are being properly applied.

What percentage?

You can guide your choice of a percentage-of-sales figure by finding out what other businesses in your line are doing. These percentages are fairly consistent within a given category of business.

It's fairly easy to find out this ratio of advertising expense to sales in your line. Check trade magazines and association. You can also find these percentages in Census and Internal Revenue Service reports and in reports published by financial institution such as Dun & Bradstreet, the Robert Morris Associates, and the Accounting Corporation of America.

Knowing what the ratio for your industry is will help to assure you that you will be spending proportionately as much or more than your competitors; but remember, these industry averages are not gospel. Your particular situation may dictate that you want to advertise more than or less than your competition. Average may not be good enough for you. You may want to out-advertise your competitors and be willing to cut into short term profits to do so. Growth takes investment.

No business owner should let any method bind him or her. It's helpful to use the percentage-of-sales method because it's quick and easy. It ensures that your advertising budget isn't way out of proportion for your business. It's a sound method for stable markets. But if you want to expand your market share, you'll probably need to use a larger percentage of sales than the industry average.

Which Sales?

Your advertising budget can be determined as a percentage of past sales, of estimated future sales, or as a combination of the two:

1. Past Sales. Your base can be last year's sales or an average of a number of years in the immediate past. Consider, though, that changes in economic conditions can make your figure too high or too low.

2. Estimated future sales. You can calculate your advertising budget as a percentage of your anticipated sales for next year. The most common pitfall of this method is an optimistic assumption that your business will continue to grow. You must keep general business trends always in mind, especially if there's the chance of a slump, and hardheadedly assess the directions in your industry and your own operation.

3. Past sales and estimated future sales. The middle ground between an often conservative appraisal based on last year's sales and a usually too optimistic assessment of next year's is to combine both. It's a more realistic method during periods of changed economic conditions. It allows you to analyze trends and results thoughtfully and to predict with a little more assurance of accuracy.

Prior to opening your business you must decide upon the general Cost Level you expect to keep. Will you cater to people buying in
the large, medium, or low budget? Your choice of location, appearance of your establishment, quality of goods handled, and
solutions to be offered will depend on the clients you hope to attract, and so will your prices.

After establishing this general price level, You're ready to price Individual products. In general, the price of an item has to
cover the price of the item, the other costs, plus a profit. Therefore, you will have to markup the thing by a certain amount to
cover costs and earn a profit. In a business that sells few items, total costs can easily be allocated to each item and a markup
immediately ascertained. With many different things, allocating costs and determining markup may need an accountant. In retail
operations, goods are often marked up by 50 to 100 percent or more simply to earn a 5 percent to 10% gain!

Let us work through a markup illustration. Suppose your organization sells 1 product, Merchandise A. The provider sells Product A
for you for $5.00 each. You and your accountant decide the costs entailed in selling Product A are $4.00 per item, and you desire
a $1 per item gain. What is your markup? The sale price is: $5 and $4 and $1 or $10; the markup consequently is $5. As a percent,
it's 100%. So you have to markup Merchandise A by 100% to produce a 10% gain!

Many small business managers are interested in knowing what Industry markup norms are for various products. Wholesalers,
distributors, trade associations and company research companies publish a huge assortment of such ratios and business statistics.
They're useful as recommendations. Another ratio (along with the markup percentage) significant to small businesses is your Gross
Margin Percentage.

The GMP is comparable to your markup percentage but whereas markup Refers to the percent over the price to you of every item you
have to set the selling cost in order to cover the other costs and make profits, the GMP shows the relationship between sales
revenues minus the expense of the product, which is your gross margin, and your sales revenues. Exactly what the GMP is telling
you is your markup bears a certain relationship to your sales revenues. The markup percent along with the GMP are basically the
same formula, together with the markup referring to individual product pricing and GMP referring to the product prices times the
amount of items sold (volume).

Perhaps an illustration will clarify the point. Your company sells Product Z. It costs you $.70 each and you choose to sell it for
$1 each to cover costs and gain. Your markup is 43%. Now let up state you sold 10,000 Product Z's Last month hence producing
$10,000 in earnings. Your price to purchase Product Z was 7000; your gross profit margin was $3,000 (revenues minus cost of goods
sold). Additionally, this is your gross mark for your month's volume. Your GMP would be 30 percent. Both these percentages use the
same primary amounts, differing only in division. Both are utilized to establish a pricing system. And both are published and can
be utilized as guidelines for small businesses beginning out. Often managers decide what Gross Margin Percentage they will have to
earn a profit and simply visit some published Markup Table to discover the percentage markup which correlates with that margin
condition.

While this discussion of pricing might seem, in some respects, to Be directed only to the pricing of retail product it could be
applied to other types of companies too. For services the markup has to pay for selling and administrative costs in addition to
the immediate cost of performing a particular service. If you are manufacturing a product, the costs of direct labor, materials
and supplies, parts purchased from other issues, special tools and equipment, plant overhead, selling and administrative
expenditures must be carefully anticipated. To compute a price per unit needs an estimate of the amount of units you plan to
produce. Before your factory gets too big it would be smart to consult an accountant about a cost accounting system.

Not all things are marked up from the average markup. Luxury articles Will require more, staples less. For instance, increased
sales volume from a lower-than-average markup on a certain thing - a"loss leader" - can bring a higher gross profit unless the
purchase price is reduced too much. Then the consequent increase in sales will not increase the entire gross profit enough to
compensate for the minimal cost.

Sometimes you may wish to sell a particular item or service in a lower Markup in order to boost store visitors with the hope of
increasing earnings of Regularly priced product or creating a high number of new service contracts. Competitors' costs will also
govern your prices. You Can't market a Product if your competitor is greatly underselling you. These and other Factors May cause
you to vary your markup among items and services. There is no magic Formula that will work on each product or every service all
the time. However, You should remember the overall average markup that you want to make a Profit.

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