Most SMEs and startups are often reminded to have a budget for advertising. Why? Because people will typically not buy a product they do not know about. Advertising as a concept sums up all the activities a business undertakes to bring its product to the awareness of prospective customers, and get them to make a purchase.
That said, the end goal of advertising is sales.
If you are spending money on advertising, you expect to make sales in the short term, or at least get leads that will eventually convert into buying customers. If you are spending money on ads, and not closing sales from those activities, the right thing to do is stop and reevaluate. Data shows that almost all sectors are now spending more on social media advertising than they ever did.
So what is ROAS?
Return on Advertising Spend (ROAS) is a calculation to determine the profitability of your advertising drive, relative to how much you spend on it. If you understand how to calculate Return on Investment (ROI), this should be easy peasy because in this case, you are considering how much you spend on advertising versus, how much revenue comes from your advertising drive.
To calculate your ROAS, you first should have a clear picture of how much money you have spent on advertising over a period of time. In this era of social media advertising, you can easily get this to get from your social media account by selecting the time frame you want.
Then you need to have the total revenue that came in from those advertising activities. If you keep financial books, you should be able to track this as well. To be very accurate, ensure not to include sales gotten from other sources like referrals, returning customers etc.
ROAS = Gross Revenue from Ad Spend – Advertising Cost
For example, if my total advertising spend in the last three months is N25,000 and I have sold goods worth N150,000 from those advertising activities, here is my ROAS
150,000 – 25,000 = 125,000
Remember this figure (N125,000) is still inclusive of other costs of production, so this is not the Net Profit yet.
So, how much is too much to spend on ads?
There is no fixed figure or range because how much you spend on ads will depend on the size of business and the kind of business that you so. A 20 million naira business will spend more on ads than a small business worth half a million naira. So it would be best to discuss how much to spend on advertising, in relation to the ROAS.
As a benchmark, your ROAS should be at least four times your advertising spend. This is because you also have to factor in other costs of production, manpower, utilities, raw materials etc before making a profit. So, for every N1,000 you spend on Ads, you should make at least N5,000 in revenue, to give a ROAS of N4,000 (4x your advertising spend).
However, some businesses can survive with a lower ROAS, particularly if the business has lower operations costs. A business that operates completely online will not have the additional costs associated with brick-and-mortar retailers. In fact, for most online businesses, online advertising spending and the cost of internet access might be their major operations costs. Some businesses have so many other costs that they will need thir ROAS to be up to 6x their advertising spend, to remain in business.
You have to figure out where your business falls, and then decide what your benchmark ROAS should be. If it turns out that your ROAS is lower than it should be, re-strategise and reevaluate what you need to do better.