Advertising budget: how much of your revenue should it be?

You will often hear that businesses should spend a set share of revenue on marketing. The advice is common because it is simple, but it hides the real decision.

How the rule of thumb is used

Some owners set the budget as a share of last year's revenue, or of the revenue they hope to earn. It gives a number to start from, and it keeps spending in proportion as the business grows.

Why it falls short

• Industries and business stages differ a great deal, so one number cannot fit all.
• A new business with no history needs to spend more to be found, and a busy one may need little.
• It ignores whether advertising actually pays. A channel that returns more than it costs deserves more money, whatever the percentage.

A better method: work from customer value

1. Estimate what a new customer is worth in gross profit.
2. Work out how many leads it takes to win one customer.
3. That gives the most you can pay for a lead and still profit.
4. Test a budget for a fixed period and compare the real cost of a customer with that ceiling.

Use the percentage as a sanity check

After setting a budget from customer value, compare it with your revenue. If it is far above what is typical for your industry, make sure you have a reason, such as rapid growth. If it is far below, check that you are not missing easy opportunities.

Include all costs

Count ad spend, agency or freelancer fees, design, software and your own time, so you see the true cost of getting customers.