If you are needing to create a budget for paid ads, you may find yourself wondering where to even start. Between all the different ad platforms and types of digital ads available – it can be overwhelming to even know where to start. At Blaze, we’ve found a proven method that work well for most businesses. Let’s take a look at the best way to create an ad budget while ensuring profitability.
Step One: Determine Your Profit Margin
The first crucial step is to identify your product’s profit margin. To calculate your profit margin, you subtract all costs associated with customer acquisition from the product’s price. This number will help you ascertain the maximum amount you can invest to acquire a customer.
For example, if it costs $100 to acquire a new customer (that takes into account your ad spend and cost-per-click), that customer brings an average profit margin of $120, you’ll want to adjust your budget so that the cost per new customer remains below $100. In this case, setting a budget of $99 or less would be essential for profitability.
Next you need to determine the average customer Lifetime Value (LTV). To compute the LTV, divide the average profit margin by the churn rate.
So using our numbers earlier, spending $100 to acquire a customer generates an average revenue of $120 per year over three years with a 10% churn rate. You take $120 / .25 and your LTV is $40. From there you take the LTV and divide the acquisition cost, to figure out your percentage so you can use that to scale your budget accordingly. $40 LTV out of $100 acquisition cost is 40%. Based on this information you want to set your budget at or below your LTV of Consequently, it’s prudent to set your budget at around 40% or less of your LTV.
Step Two: Determine Your Desired Customer Acquisition
Now that you know your profit margin and LTV, you need to decide how many new customers you want to acquire. This will be the foundation for your total ad budget. For example, if acquiring a new customer costs you $100 and your goal is to gain 10 new customers a month, your ad budget would require $1000 in order to achieve your customer acquisition goal.
Keep in mind that this budget is a GUIDE – it cannot guarantee that you will get those 10 new customers. That largely depends on your offer and how effectively you optimize your conversion rate. But by carefully managing your budget and continuously optimizing, you can increase the odds of having a successful and profitable ad campaign.
Step Three: Determine ROAS
After you have a baseline for your budget, you need to look at your return on ad spend (RAOS) to determine if it is profitable or needs optimization. Calculating your ROAS can be complicated because there are a lot of different variables depending on your business, offer, target markets, and more. But if you have historical data as a reference, that will help you determine how your new campaigns are performing compared to past campaigns.
For most businesses, you are initially looking for a 3:1 ROAS (If you spend $100, you want to see $300 in profits). This ratio typically will cover product and marketing expenses and helps ensure that you are on track to remain profitable.
Step Four: Distribute Funds And Optimize Campaigns
After you have all these measurements – profit margin, LTV, and ROAS – you can start to distribute your budget to your different ad campaigns. There may be instances where you want to allocate more funds to a specific platform or campaign up front to test their effectiveness, but generally we recommend that you start conservatively and then gradually increase as the campaign progresses.
In addition to basing budgets on ROAS goals and LTV targets, consider other essential factors when allocating your ad spend. You are going want to make sure that you are considering platforms that you are placing ads on; are they tailored for your ideal customers? Running ads on TikTok might not be the best move if you are targeting an 60-70 year old market.
There is no “one-size-fits-all” approach to creating a budget for paid ads. But if you take the time to look at the data mentioned in this article you can develop a budget that will fit YOUR business needs and goals. The biggest key to having a profitable ad campaign is to be flexible and to regularly monitor them. By being adaptable and well-aware of your metrics, you can continuously refine your budgeting process and make decisions that will help your paid ads succeed.