The Ratio of Gross Revenue to Advertising
Among all business expenses, advertising has the greatest impact on sales. Properly managed, it can increase revenues and maximize sales. Some business owners spend funds on advertising without actually knowing how to measure its effectiveness. The gross revenue-to-advertising ratio or advertising-to-sales ratio allows you to gauge the effectiveness of such expenditures in improving your sales levels.
Advertising-to-sales ratio is a financial analysis tool designed to measure the efficiency of advertising expenses in generating sales. It measures what percentage of gross sales is spent on advertising expenses. Comparing this ratio against industry-average ratios allows you to see whether your expenditure is higher or lower than normal levels. Comparing the ratio against your past ratios allows you to measure the results of advertising campaigns.
Dividing advertising expenses by gross sales for a given period yields this ratio. Multiplying the ratio by 100 expresses it in percentage terms. Gross sales is used instead of net sales, because advertising affects all sales regardless of whether or not the merchandise was returned and because sales returns are an after-sales transaction.
As an example, assume that ABC Company’s income statement at the end of a given month shows gross sales of $1 million and an advertising expense of $50,000. Dividing the period’s advertising expense of $50,000 by gross sales of $1 million gives an advertising-to-sales ratio of 0.05. Multiplying the ratio by 100 gives you 5 percent. This means that 5 percent of gross sales was spent on advertising expenses.
The lower the ratio is, the more efficient you are in using your advertising budget. A ratio that is lower than the industry-average advertising-to-sales ratio indicates you are more efficient in using your budget than most competitors in the industry. A high advertising-to-sales ratio may indicate that high advertising expenses resulted in low sales revenue.