If you have a business and you want to grow, then you probably ask yourself, “How much should my marketing/advertisement budget be?”
Several factors determine your marketing budget, and knowing that budget is an advantage that will help you crush your competitors.
There’s no exact number to tell you how much you should spend on advertisement because each business is unique and the incomes are different, but here we’ll teach you how to calculate that based on some specific factors.
Determine your average order value (AOV)
Average order value is the average price your customer pays for your service or product.
So if you have one product that is 10$, your AOV will be 10$, but if you have multiple products and services, finding out your AOV can take a little more work. To do so, you need to go back and look at some historical data.
If you have an established company, gather some historical data that divides your total revenue by your total clients.
Determine your lifetime value (LTV)
Lifetime value or LTV is the total revenue (or value) you receive from your customers. For example, if you have an AOV of 100$ and your customer buys from you ten more times, your LTV is 1000$. It’s incredibly critical to know how much your LTV is while thinking about your marketing budget.
This simple formula will help you understand all of this better:
AOV × Purchase frequency = LTV
To be one of the most successful companies, you need to increase the LTV of your customer base constantly. Selling one single product is an easy thing to do. The real thing you need to do is get the client to come back again for more.
Determine your customer acquisition cost
Customer acquisition cost (CAC) is the amount of money you are willing to pay to acquire a customer. This step helps you determine how much money you are ready to burn before you are profitable, which is especially important if you bootstrap or use personal loans to get your business started because, in that case, every dollar counts. On the other hand, it’s probably less important if you have some capital from the outside investor seeking appreciation instead of profitability.
To desire your CAC, you must consider all your expenses like staffing cost, product cost, office space, shipping, and more.
For example, if your LTV is 1000$ and your expenses are 100$, and you want to be at least 10% profitable,
your MAX CAC is 800$.
LTV × Profit margin = CAC
However, it can take you a lot of time to receive that 1000$, but you’ll have to burn 800$ right now, which is a positive return investment, but you can quickly run out of cash.
So, a lower desire CAC displays a lower rest tolerance or a lower amount of cash to spend, and a higher desire CAC shows a higher rest tolerance or more money to spend.
Determine your desired return on advertising spend
Return on AD spend (ROAS) is multiple on the money you pay against the money you make. For example, if you spend 100$ and then make 150$, then your ROAS is 1.5.
Let us demonstrate this for you. Let’s say you want at least 20% gross profit, and your CAC is 800$, which means your desired ROAS would be 1.25.
800$ CAC × 1.25 ROAS = 1000$ LTV
In life marketing, it’s best to target a minimum of 1.5 ROAS, but we see that number being much higher and much lower. So the key is knowing how much you’re willing to burn.
Now let’s tie all of this together into your marketing/advertising budget.
You need to know that it’s recommended to “set an annual marketing budget.” This way, you’ll have some good data on auto metrics that we just went over after about a year.
Then you review. During your review, make sure you’re increasing your average order value, lifetime value, and return on investment, especially before you decide to make any changes to your marketing budget.
How to find the budget?
There are two ways to do so:
- Growth method: this method is ideal for anyone who’s making under 150K$ in annual revenue. You’re likely a 1 to 3 man company with maybe a few affordable contractors at this level. So all you need to do is focus on growth.
We recommend you spend at least 12$-24K$ annually on marketing and advertising. And along the way, make sure you’re gaining attraction (gaining some data on your AOV, LTV, ROAS without trying to perfect it yet). After a year, you need to go back and look at your results and make some honest conclusions.
- Revenue method: this method is ideal for anyone who is making over 250K$ in annual revenue.
Here is how it works, you’ll allocate at least 10% of your revenue to your marketing cash, so if you make 250K$ a year, 10% of that (25K$) will go to marketing cash. This is the amount of money you can burn each year with maintaining profitability. Now you need to figure out how quickly you want to grow.
Recall that your CAC is the money you are willing to spend to acquire a customer. So if your CAC is 800$ and your annual marketing cash is 100K$, then you can expect to gain about 125 customers per year. Therefore the formula for your marketing budget is:
CAC × Customers = Marketing Budget