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. All Methods of Establishing An Advertising Budget require consistant overview and revision.
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.
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 ofAmerica.
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.