Each of the various ways in which to establish an advertising budget has its advantages and constraints. No method is perfect for all types of businesses, nor for that matter is any combination of methods. Concepts from several traditional methods of budgeting have been combined into three basic methods: percentage-of-sales or profits; unit-of-sales; and objective and task. You will need to use judgment and caution in choosing your method or methods. Percentage of Sales or Profits
The most widely used method of establishing an advertising budget is to base it on a percentage of sales. Advertising is as much a business expense as, say, the cost of labor and, thus, should be related to the quantity of goods sold. The percentage-of-sales method avoids some of the problems that result from using profits as a base. For instance, if profits in a period are low, it might not be the fault of sales or advertising. But if they stick with the same percentage figure, they will automatically reduce their advertising allotment. Such a cut in the advertising budget, if profits are down for other reasons, may very well lead to further losses in sales and profits. This, in turn, will lead to further reductions in advertising investment, and so on. In the short-term, a small business owner might increase profits by reducing advertising expenses, but such a policy could lead to a long-term deterioration of the bottom line. By using the percentage-of-sales method, you keep your advertising in a direct relation to your sales volume. Therefore, if sales increase your advertising should increase accordingly. Gross margin, especially over the long run, should also show an increase, of course, if your advertising outlays are being properly applied. What percentage?
You can guide your choice of a percentage-of-sales figure by finding out what other businesses in your industry are doing. These percentages are fairly consistent within a given sector of business. Knowing the advertising sales ratio for your industry will help you align your expenses with those of your competitors. You must be careful however, not to base your entire budget on these figures. Your particular situation may require you to advertise more or less than your competitors. You may feel that, at this point in your business life cycle, it is important to spend more than average on advertising. The decision is ultimately yours. After all, growth requires investment. No business owner should let any method bind him or her. It may be helpful for you to use the percentage-of-sales method because it is quick and easy. Not only is it a sound method for stable markets, but it may also keep your advertising budget from getting way out of proportion. Note: if you are looking to expand your market share, you will probably have to use a larger percentage of sales toward advertising than the industry average. What sales?
their budget can be determined as a percentage of past sales, of estimated future sales, or as a combination of the two: Past sales
their base can be last year's sales or an...