I often hear the question – should I advertise on Facebook? What about Google?
This is not a clear cut yes or no question.
Instead there are many factors that come into account when deciding if you should advertise or not.
Luckily there is one way that you can determine if advertising is good for you and your business.
This way is for you to calculate your return on investment or ROI.
The return on investment is the percentage that you earned on the money you spent advertising. Just like you have a return for an investment in the stock market, you can have a return on your business spending.
There are actually many ways that you can calculate the ROI for your company, we will start by looking at the most basic calculation. While this one is not perfect, it is the best place for you to start if you have never looked at your ROI. After that I will show you a couple advanced additions to the basic formula that you can add the more advance you become.
The formula is pretty simple: Take the sales from an advertisement and subtract out the cost of the ads. Take this number and divide it by the cost of the ads. Finally take that number and multiply it by 100. This gives you the percentage return on that campaign.
(Sales – Cost of Ad/cost of ad) * 100 = percentage return on your advertising investment.
For example if you spent $10 on advertising and had $100 in sales your calculation would be: $100 – $10 = $90, $90 divided by $10 = 9, then 9 *100 = 900% return.
I don’t know about you, but I will run that advertising campaign any day!
When deciding what is a good return you should look at a couple things:
Once you have mastered the basic ROI formula you can move on to adding advanced components that will give you better information for even better decisions!
Adding in what it costs you to deliver your product or service will give you a better look at how good your return is. Cost of goods sold is how much it costs to deliver your product.
Your new formula would be Sales minus the costs of product minus the Cost of Ad/cost of ad) * 100 = percentage return on your advertising investment.
For example if you sold candles and each candle was sold for $10 and it cost you $4 to make and ship the item. You ran an ad that cost you $100 and you sold 20 candles. Your return calculation would be:
$200 (sales) – $80 (COGS) – $100 (ad cost)/$100 (cost of ad) * 100 (how we get it into percent form) = 20% return on your money.
To take this one a step further, calculate your overhead costs per item sold or use your margin.
Sometimes it can pay off in the long run to lose money on an advertising campaign, that is if you know what you will eventually earn from that customer that you get.
The Lifetime value of a customer is your average sales for the entire time that person is your customer.
For example if you make baby clothing and know that on average each customer will buy four dresses over two years, you could calculate the lifetime value of your customer as being 8 dresses. Then determine your margin on each product, so lets assume it is 25% per dress and your dresses are typically $50, thus your profit per dress is $12.50. So after 8 dresses the life time value is $100 per customer.
Thus you may be willing to spend $20 to get the customer even though you would lose money on the first sale.
To get even more detailed on this you can figure out the discount value so you can account for the time value of money. I personally would only worry about this if the lifetime value of a customer involves a long period of time. For example Starbucks or Amazon, will keep a customer for many many years and this would impact the calculation for their lifetime value by quite a bit.
Knowing how much it really “costs” you to advertise will help you grow your business faster by allowing you to focus on the best sales areas. Keep in mind when you are first starting out you do need to give yourself time to fine tune your ads. Watching your ROI with each change to your ad will help you master advertising!