Determining Advertising Budgets for Small Business
by Chad Rueffert

One of the first questions asked of marketing professionals by small retailers is how much to spend on advertising.  Small companies, even more so than large corporations need a definite budget set aside for advertising because they have smaller margins for error. A budget forces retailers to set goals so they can measure the success of their promotions. A budget helps retailers to choose between the variety of available advertising vehicles and allows them to say no to those they can’t afford. And, a budget is more likely to result in a well-planned campaign executed on a set timeline. Promotion and advertising is a controllable, measurable expense, and the budget is set in place to control those expenditures.  Spending too much on promotion can result in cash flow problems and smaller return on investment.  Spending too little can be just as bad in terms of lost sales and diminished company or product awareness.

While each situation is different, there are two basic methods that can be followed when determining advertising budgets.  

Budgeting By Percentage of Sales or Profits

The most widely used method of establishing a marketing budget is to base it on a percentage of actual sales or profits.  Because marketing is a business expense like any thing else, it can be related to the quantity of goods sold over a certain period.  

In most situations, basing the budget on a percentage of sales rather than profit avoids certain problems.  Actual company profits can fluctuate due to situations not related to advertising or promotion (increased wages, higher cost of goods, new equipment purchases, etc.)  If profits are down for these reasons, a cut in the advertising budget may very well lead to further losses in sales and profits.  This in turn will lead to even further cuts in the advertising budget.  

By using the percentage of sales method, it is possible to keep advertising in consistent relation to sales volume.  The budget can be determined as a percentage of past sales, of estimated future sales, or as a combination of the two.  In a stable market, using past sales as your indicator works well.  However, if your company is growing quickly, or experiencing rapid changes, projecting future sales may be more appropriate.  In most cases, a combination of the two is best.

The big questions is what percentage of sales to use to determine the budget.  National data is available to determine industry averages and can be found from companies such as Dun and Bradstreet or from industry associations.  This is an excellent place to start, but should not be the only determining factor.  If your competitors are spending 3.0% percent of their sales volume on advertising and you want to increase your market share by attracting customers away from them, you will probably need to spend more than they do.  

Even within narrow industry types, average promotional spending varies widely. Clothing stores often spend as much as 4% of their sales volume on advertising, and rarely less than 2%.  Even so, that is a 100% variance.  Restaurant spending can vary from less than 1% to over 3%.  Bookstores and gift shops range from 1.5% to nearly 3%.  These numbers vary widely by size of retailer, whether it is a franchise or independent, and by the geographical region.  Contact your industry association or advertising agency if you are interested in up-to-date statistics for your business.

Budgeting By Objectives & Goals

This method of budgeting requires more strategy and effort, but is far more accurate and appropriate for growth oriented companies.  The percentage of sales method determines the amount retailers will spend with little consideration of their marketing goals.  The objectives and goals method first looks at what needs to be accomplished and then allocates an appropriate budget.

It is important to set specific, achievable objectives.  Is your goal to increase sales by 20%?  Perhaps you could go so far as to state a goal of “Increase entrée sales by 20% during the hours of 1 to 3 by attracting diners from the nearby medical facility.”  This is a marketing strategy, and the most important aspect of determining your budget.  Once the strategy is in place, you can decide which medium will be best for reaching these people, and estimate how much will need to be spent to attract enough people to increase your sales by 20%.  Be sure to measure your results to determine whether you need a different strategy or a larger budget in the future.

Whether you choose to determine your advertising budget through a percentage of sales, through objectives and goals, or through a combination of both, at least you’ll have a plan in place.  This plan will allow you to control your expenditures, make better advertising decisions, and determine the success and return on investment of your marketing dollars.