Definition
The Percentage-of-Sales Method is a budgeting technique used by businesses to allocate their advertising budget. The allocation is based on a set percentage of past sales or a forecast of future sales. This method is favored for its simplicity and its direct linkage of advertising expenditures to the business’s sales figures. Typically, management decides on the percentage figure, which is often derived from the industry average or the company’s historical advertising spending.
Examples
Historical Sales Example:
- A company that achieved sales of $1,000,000 last year decides to allocate 5% of this amount to its advertising budget for the following year. Therefore, the advertising budget for the coming year would be $50,000.
Forecasted Sales Example:
- Supposing a company forecasts sales of $2,000,000 for the upcoming year, and it sets the advertising budget at 6% of this figure. The advertising allocation would be $120,000.
Industry Average Example:
- If the standard advertising expenditure in the industry is 7% of sales, a company with previous year’s sales of $800,000 may choose to allocate 7% of this amount for future advertising, resulting in a budget of $56,000.
Frequently Asked Questions (FAQs)
1. Why do companies use the Percentage-of-Sales Method?
- Companies use this method due to its simplicity and the straightforward way it directly ties the advertising budget to sales figures, making it easy to justify expenditure levels.
2. What are the disadvantages of the Percentage-of-Sales Method?
- The method can be overly simplistic and may not account for significant changes in market conditions, competitive actions, or new marketing opportunities. Additionally, it may underfund advertising in times of declining sales, which could further affect sales negatively.
3. How do companies determine the percentage to use?
- The percentage is generally based on industry standards, the company’s historical spending, or management’s strategic decisions.
4. Can the Percentage-of-Sales Method be applied to startup businesses?
- It can be challenging for startups to use this method since they lack historical sales data. However, startups might allocate their budget based on sales forecasts and industry benchmarks.
5. Is the Percentage-of-Sales Method suitable for all types of businesses?
- While it’s common, it may not be suitable for every business, particularly those in highly volatile or competitive markets where more strategic and flexible budgeting methods might be necessary.
Related Terms with Definitions
- Advertising Budget: The amount of money allocated by a business for promotional activities over a specified period.
- Sales Forecast: An estimation of future sales, based on historical data, market analysis, and sales trends.
- Budget Allocation: The process of distributing financial resources among various departments or projects within an organization.
- Industry Average: A benchmark that represents the standard or typical percentage spending in the industry.
Online References
Suggested Books for Further Studies
- Advertising and Promotion: An Integrated Marketing Communications Perspective by George E. Belch and Michael A. Belch
- Marketing Management by Philip Kotler and Kevin Lane Keller
- Strategic Marketing for Non-Profit Organizations by Alan R. Andreasen and Philip Kotler
Fundamentals of Percentage-of-Sales Method: Marketing Basics Quiz
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