Financial Ratios – Marketing Budget

Dear M & M:

What can financial ratios tell me about my business?

-Roberto

Dear Roberto:

Financial ratios can help you identify strengths and weaknesses. They can best be used to make comparisons of standard ratios used in your industry. Lenders look very closely at a business’s financial ratios. Here are some categories of business ratios with examples of some ratios one should use.

Asset Management:  Accounts Receivable Turnover (how many days it takes to collect money owed to you) – lower answer is better.  Inventory Turnover (how many days does it take you to sell your inventory) – lower answer is better.

Liquidity Ratios: Working Capital (cash available to pay bills) – higher number is better. Quick Acid Test (total current assets less inventory available to pay current liabilities) – answer should be 1 or higher. Current Ratio (current assets compared to current liabilities) – the higher the number the better should be over 2.

Debt Management Ratios: Leverage (total liabilities divided by total capital) – determines if a company has enough equity, lower number the better, should be less than 3. Accounts Payable Turnover (shows how quickly a company pays its supplies) – generally less than 30 days is better.   

Profitability Ratios: Profit Margin on Sales (net profit divided by net sales) – the higher the number the better – if the profit margin is too low, prices are too low or expenses and/or cost of goods are too high. Cash Flow to Current Maturities (shows your ability to pay term debt after owner’s withdrawals or net profits) – answer of 2 or more is preferred.  Remember ratios should be compared to prior years, acceptable lending ranges, and industry averages. Differences in industry averages can occur due to business size, age of the company, managers, and individual business operations. Remember a ratio of 19% compared to 20% seems small. If sales are $4 million a 1% difference is $40,000. If net profits are $100,000 than the $40,000 difference is very important. Trade associations for your business, magazines, newspapers, SBA, and your local library can be very helpful in providing assistance. Victoria Yarbrough, Leisure & Library Services Director, City of Sierra Vista Public Library, 2600 E Tacoma Street and her staff would be happy to assist.

 -M&M

Dear M & M:

Just how big should my marketing budget be? How much should I spend on advertising?

–Suzan

Dear Suzan: 

Because marketing costs and needs vary widely it is hard to come up with a simple rule on this. Total advertising expenditures in the first quarter of 2011 in the U.S. increased 4.4 percent from a year ago and finished the period at $32.5 billion, according to data released by Kantar Media. A popular method is to allocate a percentage of gross sales. If you are launching a new product or service generally advertising expenditures are more. Many industries where gross margins are higher such as fragrances and pharmaceuticals advertising percentages are higher. Industries that are very competitive like the automotive industry spend a lot of money advertising (automakers’ generally spend 2.5% to 3.5% of revenue on marketing), liquor (5.5% to 7.5%), packaged goods (4% to 10%). Some businesses compare advertising budgets to similar businesses and estimate the competitions budget and formulate a plan based on what the competition is doing. While Wal-Mart might spend a meager 0.4% of sales on advertising, the sheer size of the company turns that tiny percentage into a significant budget. Wal-Mart’s nominally higher-margin competitor, Target, spends closer to 2% of its sales on advertising, while Best Buy, as a specialty retailer, spends upwards of 3%. Finally, more upscale stores like Macy’s typically spend on the order of 5%. –Bloomberg Business Week. One thing for certain if your sales are slow do not slow down your marketing efforts.  Here is what some of the more successful companies are spending.

Microsoft – more than 20 percent of their annual revenue or $11.5 billion

Coca-Cola – more than $2.5 billion

Yahoo – more than 20 percent of their annual revenue or $1.3 billion

eBay – 14 percent to 15 percent of its revenue – which was $871 million, much of that to advertise on Google. –Marketing Pilgrim. Bloomberg BusinessWeek suggests your first step should be to try to find out what the advertising-to-sales ratio typically is in your field. Public companies in your industry may give a figure for their marketing spending in their financial statements (found in their annual reports). With a simple calculation, you can figure out what percentage of their overall revenue that represents. If you can’t find any public companies that seem similar enough to yours, you might want to start at 5% and then adjust your projected spending up or down based on the size of your market, the cost of media, what you can learn about how much your competitors are spending, and the speed at which you’d like to grow.

-M&M

To ask your questions: Call the Small Business Development Center(SBDC) at Cochise College (520)-515-5478 or email schmittm@cochise.edu or contact the Sierra Vista Economic Development Foundation(EDF) at 520-458-6948 or email  hollism@svedf.org

 

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