Advertising Budget

What is an Advertising Budget?

An advertising budget is a company’s allocation of promotional expenditures over a specified time period. It is a measure of a company’s planned expenditure on accomplishing marketing objectives. The advertising budget is where a company’s strategic marketing objectives and cost-benefit analysis converge in its operational plans.

The Three Pillars of the Advertising Budget

1. Situational Analysis

A situational analysis identifies the challenges and opportunities facing a company both internally and externally. The structured analysis breaks down the company, the customers it serves, and the competition in the market. It relates socio-cultural, technological, economic, and political-regulatory trends to a company’s operations. Ultimately, the situational analysis sets the framework for the development of a company’s strategic plan.

2. Segmentation, Targeting, and Positioning (STP)

A segmentation, targeting, and positioning (STP) analysis identifies potential opportunities for an organization to pursue. Segmentation is the process where customer groups are identified. The customer groups are formed by sorting through geographic, demographic, and psychographic variables.

Targeting involves selecting the most attractive customer groups. Factors that influence how attractive a consumer group can be are market size, spending power, or even customer loyalty. Once market segments are ordinally ranked, the most valuable are targeted.

Positioning requires developing strategies pandering the target markets. The previously completed situational analysis provides background information to build a positioning strategy. The purpose of the positioning strategy is to ensure that the value proposition connects with the targeted market.

A thorough STP analysis is critical in maximizing the impact of an advertising campaign. In addition, it is important to formulate streamlined strategies to reduce excess costs.

3. Return on Investment

Quantifying an advertising campaign’s impact on a company’s operating income is critical to understanding the relationship between advertising expenditure and revenue generation. A cost-benefit analysis is commonly conducted to assess the net financial benefit of a project undertaken.

The cost-benefit analysis discounts forecasted after-tax operating cash flows to its Net Present Value (NPV). For any given expenditure on advertising, a company should aim to maximize the NPV of advertising expenditure.

Impact on Income Statement

Advertising expense is accounted for as selling, general, and administrative (SG&A) expenses. SG&A expenses impact operating income, and by extension, net income. A company’s operating sector exerts a large impact on selling, general, and administrative expenses’ correlation with net income.

In the fast-moving consumer goods (FMCG) sector, where products are sold in high volumes at low prices, advertising expenditure makes up a larger proportion of revenues. It is important to assess the benefits and costs of an advertising project.

After quantifying the campaign’s impact, the company can then justify its expenditure and budget accordingly. Ultimately, each company must budget for advertising relative to maximizing shareholder wealth.

Industry-Normal Advertising Budget Practices

Common advertising budget methods include:

1. Percentage of Sales Method

Commonly, a company’s advertising budget is a percentage allocation of projected revenues. Accurately budgeting advertising expenditure requires an in-depth analysis of historical data to better understand the relationship between advertising and revenues.

Business-to-business companies generally spend between 2%-5% of their revenues on advertising. On the other hand, business-to-consumer companies generally spend between 5%-10% of their revenues on advertising.

2. Competitive Parity Method

The competitive parity method is a common strategy utilized by companies that wish not to be out-advertised by the competition. The strategy involves using competitor advertising spending as a benchmark for a company’s own spending.

However, budgeting the same amount of money does not guarantee the same outcome for a company. Therefore, the competitive party method comes with limitations.

3. Objective and Task Method

The objective and task method is commonly used by large corporations. It brings forth is a strong correlation between advertising spending and overall marketing objectives. The method is only as useful as its underlying strategic objectives.

Optimizing the Advertising Budget

The Dorfman-Steiner Rule is an economic theorem that optimizes advertising expenditure. The theorem states that a company can drive revenue generation through advertising expenditure or decreasing a good’s price.

Specifically, the Dorfman-Steiner Rule states that a company’s advertising expenditure is at its profit-maximizing equilibrium when an additional dollar of advertising just produces an additional dollar of net revenue. The Dorfman-Steiner rule applies only to profit-maximizing monopolists.

More Resources

CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

• 5 P’s of Marketing
• Return on Ad Spend (ROAS)
• Total Addressable Market (TAM)
• Walmart Marketing Mix
• See all accounting resources