# Marketing Math # How to Back Into a Budget for Advertising

We have all heard the quote from John Wannamaker regarding advertising, “Half the money I spend on advertising is wasted; the trouble is, I don’t know which half.”  However, when your begin to understand that advertising is an investment instead of cost item in your profit and loss statement, you can create a simple formula to determine exactly how much you should be investing in advertising and how much of a return you can expect from that investment.

The next number to determine is your conversion rate (CR). Your conversion rate is the percentage of interested leads that actually “convert” to paying customers.  If your conversion rate is 20%, that means 1 out of every 5 interested leads will convert to a paying customer.  A 50% conversion rate would be 1 out of every 2 leads.

Now we can put this all together. We’ll use some easy numbers to demonstrate the formula to determine what you will need your cost per lead (CPL) to be.  Let’s say the profit margin (PM) on your product is \$1,000.  You want your conversion ratio (CR) to be 5 to 1, meaning for every \$1,000 you invest in advertising you want to see a return of \$5,000 in profits. If we anticipate your conversion rate to be 20%, we can now plug in the numbers to determine what your maximum cost per lead (CPL) will need to be to achieve the 5 to 1 ratio.  Let’s run the numbers for 100 leads at a cost per lead of \$40.

100 leads x \$40 cost per lead (CPL) = \$4,000 in advertising spend

Those same 100 leads will convert into 20 paying customers at a 20% conversion rate (CR)

20 paying leads multiplied by \$1,000 in profit margin (PM) = \$20,000 in profit

\$20,000 in profit subtracted by \$4,000 in advertising spend = \$16,000 net profit after advertising

Your Net Profit to Advertising ratio is exactly 5 to 1.

100 leads x \$30 cost per lead (CPL) = \$3,000 in advertising spend

Those same 100 leads still convert into 20 paying customers at a 20% conversion rate (CR)

20 paying leads multiplied by \$1,000 in profit margin (PM) = \$20,000 in profit

\$20,000 in profit subtracted by \$3,000 in advertising spend = \$17,000 net profit after advertising

Your Net Profit to Advertising ratio just jumped to 6.67 to 1.

These scenarios are based on some very simple figures, but the formula works. The biggest variables in advertising will be your cost per lead (CPL) and your conversion rate (CR). However, your desired advertising spend to profit margin ratio should remain consistent, so you can continually optimize your campaigns to improve your CPL and CR numbers. In fact, it will be imperative to do so.

Our final example will use the same cost per lead of \$30 but a lower conversion rate of 15% to demonstrate how that figure can also affect your return on investment.

100 leads x \$30 cost per lead (CPL) = \$3,000 in advertising spend

Those same 100 leads still convert into 15 paying customers at a 15% conversion rate (CR)

15 paying leads multiplied by \$1,000 in profit margin (PM) = \$15,000 in profit

\$15,000 in profit subtracted by \$3,000 in advertising spend = \$12,000 net profit after advertising

Your Net Profit to Advertising ratio returns to 5 to 1.

In our next post, we’ll cover one advertising option that can truly make a difference in your advertising budgets and spending. It’s called “per inquiry” advertising and is based on agreeing in advance to what your cost per lead dollar amount will be BEFORE spending any money.