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Understanding and Calculating ROAS

About the Article

If you’re a typical business owner, you invest several percentage points’ worth of annual revenue in advertising. However, the revenue this investment generates may vary widely. Your return on ad spend could be more than 1000 percent, or a fraction of that number.

Given the significant investment businesses make in advertising and the variability in the return on said investment, it’s critical to track your return on ad spend, or ROAS, carefully. By assessing ROAS carefully, you’ll be able to identify which advertising channels and strategies deliver the strongest results, and avoid spending money on those which don’t.

To help with ROAS evaluation, this article explains what ROAS means, why it’s important, and how to calculate ROAS effectively.

What is ROAS?

Return on ad spend, or ROAS, is a measure of how much revenue your business generates for each dollar you invest in advertising. In other words, it’s a metric quantifying the return on investment in advertising.

Importantly, even though ROAS is typically used as shorthand for the term “return on ad spend,” it’s not limited to assessing the effectiveness of ads narrowly defined. ROAS instead assesses the return on investment of all of your advertising initiatives, including strategies such as social media marketing and content marketing, which may not involve ads in the traditional sense.

The ROAS Calculation

The formula for calculating ROAS is simple:

ROAS = (Total sales generated through advertising) ÷  (Total advertising costs)

Just divide the total value of the sales generated through your advertising by the total cost of your advertising campaigns.

For example, if you spend $1,000 on advertising in a fiscal quarter, and your advertising initiatives generate a total of $4,000 in sales during the same period, your ROAS is equal to $4,000 ÷ $1,000, or 4.

Expressed another way, your ROAS in this example would be equal to 400 percent (because $4,000 is 400 percent of $1,000), or a ratio of 4:1.

Why ROAS Matters 

Calculating ROAS consistently and accurately is important for several reasons:

  • Improving advertising results
    By knowing your ROAS, you can determine which advertising channels, content types and strategies are working best. In turn, you can improve the results of your advertising initiatives over time.
  • Reducing advertising costs
    By helping you to identify advertising initiatives that are under-delivering, ROAS calculations allow you to eliminate ineffective advertising investments in order to reduce your overall advertising costs while still obtaining the same results.
  • Budgeting
    When you calculate ROAS regularly and accurately, you’re in a better position to budget for future advertising costs because it spells how much you need to spend on advertising in order to achieve desired results. Advertising can thus become a fixed part of your budget, rather than an expense you juggle in an ad hoc fashion from month to month, quarter to quarter.
  • Comparing advertising to other processes
    When you know what your ROAS is, you can determine which percentage of your overall revenue comes from advertising, and which is generated through other means, such as repeat business from customers who have already been converted. This insight is helpful for determining how much overall revenue to invest in advertising as compared to other marketing strategies, such as customer rewards programs.

ROI vs ROAS

ROAS is similar to return on investment (ROI) as both metrics allow you to assess how much revenue you generate with each dollar that you invest in your business.

However, whereas ROAS measures your return on investment in ad spend specifically, ROI evaluates the return on investment in all business initiatives. For example, your business’s total ROI reflects the revenue generated not just through advertising, but also the expansion of your inventory, the growth of your sales team, and so on.

In other words, you can think of ROAS as one component of the ROI calculation. Calculating ROAS is important for assessing the performance of your advertising strategy in particular, but you’ll also want to know your ROI in order to assess the results of broader investment initiatives.

Numbers to Include in Your ROAS Calculation 

Although the formula for ROAS boils down to just two key numbers – your total advertising costs and the total revenue generated by advertising – it’s important to ensure you calculate both figures accurately.

When determining total advertising costs, include not just your direct advertising costs, such as how much you spent placing ads on websites and social media platforms, but also indirect costs, like money you spent on outside contractors who assisted with advertising content creation or ad placement. Affiliate marketing costs are another example of an indirect cost which should be factored into total ad spend.

Likewise, when you calculate the total revenue generated through advertising, be sure to distinguish between revenue generated from your advertising initiatives and your overall revenue. As noted above, you may earn revenue from initiatives outside of advertising, and you want to be sure your ROAS calculations reflect only the revenue resulting from ad spend.

It’s important to accurately assess the timeline associated with ad spend and the resulting revenue. It usually takes some time for advertising to generate leads – it takes Google’s ad platform up to a week just to determine where best to display a new ad. And once you have a lead, it could take months to complete the sales cycle and turn that lead into a paying customer.

Because of these potential delays, you’ll want to spread your ROAS calculations out over time, such as once per quarter. If you attempt to calculate ROAS over periods of time which are too short, like every week or month, you risk failing to capture an accurate picture of the association between ad spend during the period and resulting revenue.

Evaluating your ROAS 

Once you’ve committed to calculating your ROAS accurately and on a recurring basis, you’ll be able to evaluate your ROAS metrics in order to determine how well your advertising initiatives are working for your business.

When it comes to evaluating ROAS, there is no simple rule for determining what is a good or a bad ROAS. A 2016 report by Nielsen found that ROAS typically hovers around 250 percent, meaning businesses generate about $2.50 for every dollar they invest in advertising. However, the same report showed that ROAS can vary significantly between different industries (companies selling baby products saw ROAS of 371 percent, for example, compared to 267 percent for those selling food) as well as between different advertising channels (magazines generated the highest ROAS, with rates of nearly 400 percent, while digital video was the lowest, at about 150 percent).

Instead of trying to measure your ROAS success based on what other businesses are doing, the best way to evaluate your ROAS is to assess whether it’s helping you meet your own business goals. Are you able to justify the money you are spending on advertising based on the sales it generates? Or is advertising investment starving your business of cash you could use elsewhere and failing to deliver the desired results?

Consider whether your ROAS rates improve over time, and how they change based on new advertising initiatives or tweaks to your ad strategy. Ultimately, your goal in calculating ROAS should be to help improve the performance of your business over time, not match an arbitrary ROAS number.

Optimizing your ROAS with Magento

ROAS is a simple calculation which plays a crucial role in helping to shape your business strategy. By calculating ROAS accurately and consistently, you’ll know how best to invest your advertising dollars in order to drive business growth and profitability.

With Magento Commerce, establishing and assessing ROAS is easy. By providing a centralized admin interface for managing advertising campaigns and tracking sales revenue, the platform gives you all of the necessary data to calculate your ROAS in one place.

To learn more about how Magento Commerce can help with ROAS calculation and assessment, schedule a free Magento demo.

Understanding and Calculating ROAS