How much should your ad budget be?
An ad budget is not calculated as a fixed percentage of revenue, it is calculated backwards from the number of sales you are targeting. The monthly budget you need is your target number of orders multiplied by your target cost per acquisition. Any budget figure given without knowing those three numbers is a guess.
Rules like "ten percent of revenue" are industry averages and they know nothing about your conversion rate, your profit margin or your sales cycle. The same budget produces profit in one business and a loss in another.
The right method is to calculate backwards: how many sales do you want, what is the most one sale is allowed to cost you, and the product of those two is your budget.
The three numbers that set the budget
A budget is not a figure on its own, it is the result of three numbers. You can derive all three from your own data.
Input | How to find it | Value in the example |
|---|---|---|
Target number of orders | Monthly revenue goal divided by average order value | 300 orders |
Target cost per acquisition | Gross profit per order multiplied by the share you allocate to ads | $150 |
Conversion rate | From historical data, or an assumption of 1 to 2 percent | 2 percent |
The product of the first two rows is your monthly budget. The third row tells you how many visitors you need in order to actually spend it.
What the abbreviations mean
The abbreviations you meet in ad platforms are different names for the same three numbers. Each one is worth knowing before you read a single report.
Abbreviation | Stands for | What it means |
|---|---|---|
AOV | Average order value | What a customer spends on average in one order |
CVR | Conversion rate | How many out of a hundred visitors buy |
CPA | Cost per acquisition | What one sale costs you |
CPC | Cost per click | What you pay for a single click |
ROAS | Return on ad spend | How much revenue every 1 unit of spend brings back |
A step by step example
Picture a store. It sells a single product at $1,000 and wants $300,000 of revenue a month from advertising. The five steps below derive that store's budget from nothing.
How many sales are needed? Divide the $300,000 revenue goal by the $1,000 order value. You need 300 orders a month.
What is left from one sale? If the product costs you $700, a $1,000 sale leaves you $300. That is called gross profit, so your margin is 30 percent.
How much of that profit can go to advertising? Spend all of it and you make no profit at all. Allocate half, $150. That means one sale may cost you at most $150. That is your target CPA.
What is the budget? 300 orders times $150 is $45,000. That is your monthly ad budget, roughly $1,480 a day.
Can you actually spend it? At a 2 percent conversion rate, 300 orders need 15,000 visitors. Divide $45,000 by 15,000 clicks and you can pay $3 per click.
One final check: $300,000 of revenue divided by $45,000 of spend is 6.67. Every $1 you spend has to bring back $6.67 in revenue. That is your target ROAS.
The fifth step is the one most often skipped. The first four produce a consistent budget, but only the fifth tells you whether that budget can actually be spent. If clicks on your channel cost well above $3, you will not reach the goal on this budget and you have to change either the order value or the conversion rate.
Setting the target CPA correctly
The most common mistake is setting the target cost against revenue. It should be set against gross profit. On a $1,000 product with a 30 percent margin you hold $300, and advertising comes out of that amount.
Spending all of that $300 on ads brings the business to break-even. An acceptable share is usually between 40 and 60 percent of gross profit, and the example above used 50 percent.
On a one-off sale the target CPA has to stay below gross profit
On repeat purchases customer lifetime value can be used, which raises this ceiling
In categories with high return rates, calculate gross profit after returns
What to do when you are starting with no data
If you have no historical conversion data, the target CPA is an assumption. In that period the budget's job is not to produce sales, it is to produce data.
A meaningful signal needs at least 30 conversions per campaign. If your estimated CPA is $150, your learning budget is 30 times 150, or $4,500. Spread that over a month and do not change the target while you do.
Constantly changing the budget during the learning period is the most expensive mistake. Large changes to budget or bid strategy restart the learning, and money spent during that period does not turn into data.
How to split the budget across channels
If demand already exists, weight towards search. If demand has to be created, weight towards visual and video. In practice most e-commerce businesses start with search and shopping campaigns and add social channels later.
Adding channels too early splits the budget and none of them reach the learning threshold. Thirty conversions on one channel is worth more than ten each on three.
When to raise the budget
If your CPA is below target and your lost impression share is budget-driven, it is the right time to raise it. Both conditions have to hold together.
Raise it in steps of 20 to 30 percent a week rather than all at once. A sudden jump forces the bid strategy to learn again.
Use the calculator below to try it with your own numbers. Change the order value, the profit margin or the conversion rate and the budget recalculates instantly.
Sources
Ad budget calculator
Change the five numbers below to match your own business. The budget is calculated backwards from your goal.
The monthly sales figure you want ads to bring in.
What a customer spends on average. Short for AOV, average order value.
What is left as a percentage after you subtract product cost from the sale price. If $1,000 leaves you $300, that is 30 percent.
How much of that gross profit you are willing to spend on ads. Common range is 40 to 60 percent, spending all of it means breaking even.
How many of a hundred visitors buy. Short for CVR, conversion rate. If you do not know it, 1 to 2 percent is a reasonable start.
Your monthly ad budget
$45,000
About $1,480 per day
300
Orders needed
How many orders per month it takes to hit the revenue goal.
$150
Target CPA
Cost per acquisition. The most one sale is allowed to cost you.
15,000
Visits needed
How many people have to reach the site to produce those orders.
$3.00
Implied CPC
Cost per click. The most you can pay for a single click and still hit the target.
6.67x
Target ROAS
Return on ad spend. How much revenue every 1 unit of spend has to bring back.
How the number was reached
- Divide the revenue goal $300,000 by the average order value $1,000. You need 300 orders a month.
- 30% of the order value is profit, so each order leaves $300 of gross profit.
- You spend 50% of that profit on ads. One sale may cost at most $150, and that is your target CPA.
- 300 orders times $150 is $45,000 per month.
- At a 2% conversion rate those orders need 15,000 visits. Budget divided by visits means you can pay $3.00 per click.
This is not a guess, it is the arithmetic result of the goals you entered. Change a number and the result changes with it. The closer your conversion rate and margin are to your real data, the closer this is to reality.
Frequently asked questions
What percentage of revenue should go to advertising?
Should I set a daily or a monthly budget?
I raised the budget but sales did not go up, why?
How do I adjust the budget for seasonal swings?
How do I keep track of where my budget goes?
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