Return on ad spend (ROAS) is a critical number for measuring success in advertising. In short, ROAS tells how much revenue is generated for every dollar spent on an ad account, campaign, or group. Pretty basic, right?
It can be, but who wants basic anyway?
Yes, simply, it can give you a snapshot understanding of how your advertising campaigns are performing. However, when you find your true ROAS, you can paint a holistic picture of your marketing efforts and maximize your success. We will explain this further soon.
How to Calculate ROAS (The Easy Way)
Let’s start simple—the basic equation for how to calculate ROAS.
Revenue Generated From Ads / Total Ad Spend = ROAS
This equation will give you a ratio of ad spend to ad revenue. This ratio provides you with a general idea of how your ads are performing. All you need to calculate this equation is:
- The total revenue generated by an ad campaign
- The total ad spend
For example, if you ran a Facebook ad campaign that generated $60,000 in sales and your total campaign budget was $20,000, your ROAS would be 3.
While calculating ROAS this way is a great way to get a quick understanding of how your advertising campaign performs, it is only the tip of the iceberg.
How to Discover Your TRUE ROAS
The tricky thing is, ad-reporting ROAS doesn’t tell the whole story. Depending on your business, it can paint either an overly optimistic or pessimistic picture of what kind of profit your ad campaigns are actually generating for your business. To find your return on ad spend, you’ll need to incorporate some more information into your ad reporting. Let’s review a few.
Chances are pretty good that whatever you’re selling involves some cost to produce or deliver it to the customer. Understanding your profit margin is crucial to plan and execute successful advertising campaigns. A high net profit is a reflection of efficient management, low expenses, strong pricing strategies, and a good foundation for successful advertising campaigns. To calculate profit margin, use the formula
(Revenue - Cost of Goods Sold)/Revenue = Profit Margin
This is a number you will want to have set in stone before launching your advertising campaign.
Profit Margin does not cover all expenses so, if you want to find your True ROAS, you may have fixed costs that you want to incorporate into your reporting.
A common static cost when it comes to advertising is the fee that an advertising management company charges you. These fees are typically either a flat rate (static) or some percentage of your ad spend. In some cases, an ad management agency may even charge you a percentage of your advertising attributed sales.
Customer Lifetime Value
Customer Lifetime Value or (LTV) is also a critical factor in determining your ad spend return. Unless you are selling a high-profit, big-ticket item, you will need more than a single customer sale to derive any meaningful profit from your ad campaigns.
Acquiring that first-time buyer is always the most expensive conversion in any advertising effort. Once you know how often customers return to buy, how much they spend on average, and how long they remain customers, you can calculate your average customer lifetime value. Basing your ad spend of LTV can help you more confidently pay a little more to acquire first-time buyers with the knowledge that they will more than offset your advertising cost over time.
If you are a new business and don’t have enough historical data to calculate LTV, it’s always better to underreport than overreport. On the other hand, LTV is continuously changing. Updating your reporting based on churn and reactivations or returning purchases is essential for planning for profitable advertising.
As you can see, there are a variety of factors that ultimately affect your long-term return.
Let’s work through a fictional example together...
[EXAMPLE] Calculating True ROAS
Alright, so your clothing company XYZ Hoodies just launched a brand new sweatshirt design. The sweatshirts sell for $52 each, so now it’s time to factor in your expenses.
You have already put together the following expenses:
- Ad spend: $35,000
- Manufacturing cost: $12 per unit
- Transaction fees: $1 per unit
- Software fees: $120
- Marketing management cost: $900
Additionally, you know that after a sweatshirt sale, the average LTV is $59. At the end of your campaign, you yield the following results:
- Units sold =2,102 units
- Gross revenue = $109,304
Okay, so what does this mean? Let’s calculate your True ROAS.
Adding in Profit Margin, Static Costs, and Lifetime Value
Starting with the profit margin, we know each sweatshirt costs $52. So now we have to subtract the expenses that go into making your product. You already know you have a $12 manufacturing cost and a $1 transaction fee. So your new profit number is $39 after expenses, aka a profit margin of 75%.
Now to fixed costs, for this campaign, our software and marketing management fees will take out $1,020 from our overall profit. Since we have our profit margin, let’s multiply by units sold and we can subtract the static costs.
$39 x 2,102 = $81,978 - $1,020 = $80,958
One more thing, the lifetime value! Hey, it looks like each customer is worth $59 in the long-run, not $52. On average, that’s $7 more in lifetime value for each new customer. Let’s factor that in so we can accurately report the return of their acquisition. Remember, only include new customers. From this campaign, 1,881 of the sales were new customers. On average, we can predict each customer will spend $7 more dollars. That’s an extra $13,167 of profit.
$66,244 + $13,167 = $94,125
Finally, we can plug that much more accurate number of $94,125 into our ROAS equation.
$94,125 / $35,000 = 2.7 ROAS
With a 2.7 true ROAS, you can truly understand how much profit you’ve made compared to a dollar spent. Since our expenses have already been included, you can feel confident that you’ve come out of this campaign with profit.
Breaking this down also helps you identify where you can improve. For example, you generated a lot of new customers. By focusing your attention on email workflows and retargeting, you may be able to increase their lifetime value and quickly increase your campaign’s profitability.
When you approach ROAS with this mindset, you are in the driver’s seat of your marketing efforts.