An advertising budget is an estimate of a company’s promotional expenditures over a certain time period. More importantly, it is the money a company is willing to set aside to accomplish its marketing objectives.
Key Takeaways
An advertising budget is the amount of money set aside for purposes of marketing and advertisements.
The cost of advertising dollars must be weighed against the potential recognized revenues that those dollars will generate.
Demographic research and customer segmentation can create profiles to help optimize the returns to advertising spending.
Understanding Advertising Budget
An advertising budget is part of a company’s overall sales or marketing budget that can be viewed as an investment in a company’s growth. The best advertising budgets—and campaigns—focus on customers’ needs and problems and on providing solutions to these issues, not company problems such as an overstock reduction.
When creating an advertising budget, a company must weigh the value of spending an advertising dollar against the value of that dollar as recognized revenue. Before deciding on a specific amount, companies should make certain determinations to ensure that the advertising budget is in line with their promotional and marketing goals:
The target consumer — Knowing the consumer and having their demographic profile can help guide advertising spend.
Best media type for the target consumer — Mobile or internet advertising, via social media, may be the answer, although traditional media, such as print, television, and radio may be best for a given product, market, or target consumer.
Right approach for the target consumer — Depending on the product or service, consider if appealing to the consumer’s emotions or intelligence is a suitable strategy.
Expected profit from each dollar of advertising spending — This may be the most important question to answer, as well as the most difficult.
The best advertising budgets—and campaigns—focus on customers’ needs and solving their problems, not company problems such as an overstock reduction.
Advertising Budget Levels
Companies can determine their advertising budget levels in several different ways, each of which has its positives and negatives:
Spend as much as possible — This strategy, which sets aside just enough money to fund operations, is popular with startups that see a positive return on investment on their advertising spend. The key is anticipating when the strategy will start showing diminishing returns and knowing when to switch strategies.
Allocate a percentage of sales — This is as simple as allocating a specific percentage based on the previous year’s total gross sales or average sales. It is common for a business to spend 2% to 5% of annual revenues on advertising. This strategy is simple and safe but is based on past performance and may not be the most flexible choice for a changing marketplace. It also assumes that sales are directly linked to advertising.
Spend what the competition spends — This is as simple as adhering to the industry average for advertising costs. Of course, no market is exactly the same and such a strategy may not be sufficiently flexible.
Budget based on goals and tasks — This strategy, wherein you determine the objectives and the resources needed to achieve them, has pros and cons. On the upside, this can be the most targeted method of budgeting and the most effective. On the downside, it can be expensive and risky.
Appropriation is when money is set aside for a specific purpose. A company or a government appropriates funds in order to delegate cash for the necessities of its operations. Appropriations for the U.S. federal government are decided by Congress through various committees. A company might appropriate money for short-term or long-term needs that include employee salaries, research and development, and dividends.
Key Takeaways
Appropriation is the act of setting aside money for a specific purpose.
A company or a government appropriates money in its budget-making processes.
In the U.S., appropriations for the federal government are earmarked by congress.
What Does an Appropriation Tell You?
Appropriations tell us how money or capital is being allocated whether it’s through the federal government’s budget or a company’s use of cash and capital. Appropriations by governments are made for federal funds each year for various programs. Appropriations for companies may also be known as capital allocation.
Appropriation could also refer to setting apart land or buildings for public use such as for public buildings or parks. Appropriation can also refer to when the government claims private property through eminent domain.
Federal Appropriations
In the United States, appropriations bills for the federal government’s spending are passed by U.S. Congress. The government’s fiscal year runs from October 1 through September 30 of each calendar year.
Each fiscal year, the U.S. President submits a budget proposal to Congress. Budget committees in the U.S. House and Senate, then determine how the discretionary portion of the budget will be spent through a budget resolution process. The process yields an allocation of an amount of money that is assigned to the various appropriations committees. The House and Senate appropriations committees divide the money up between the various subcommittees that represent the departments that’ll receive the money. Some of the departments include the following:
Department of Agriculture
Department of Defense
Department of Energy
Department of Commerce
Department of Labor
Department of Transportation
Federal programs such as Social Security and Medicare fall under the mandatory expenditures category and receive funding through an automatic formula rather than through the appropriations process.
Congress also passes supplemental appropriations bills for instances when special funding is needed for natural disasters and other emergencies. For example, in December 2014, Congress approved the Consolidated and Further Continuing Appropriations Act, 2015. The act approved $5.2 billion to fight the Ebola virus in West Africa and for domestic emergency responses to the disease. The act also allocated funding for controlling the virus and developing treatments for the disease.
Appropriations in Business
Corporate appropriations refer to how a company allocates its funds and can include share buybacks, dividends, paying down debt, and purchases of fixed assets. Fixed assets are property, plant, and equipment. In short, how a company allocates capital spending is important to investors and the long-term growth prospects of the company.
How a company appropriates money or invests its cash is monitored closely by market participants. Investors watch to determine whether a company is using its cash effectively to build shareholder value or whether the company is engaged in frivolous use of its cash, which can lead to the destruction of shareholder value.
Monitoring Corporate Appropriations
Investors monitor corporate appropriations of cash by analyzing a company’s cash flow statement. The cash flow statement (CFS) measures how well a company manages its cash position, meaning how well the company generates cash to pay its debt obligations and fund its operating expenses. The cash flow of a company is divided into three activities or behavior:
Operating activities on the cash flow statement include any sources and uses of cash from business activities such as cash generated from a company’s products or services.
Investing activities include any sources and uses of cash from a company’s investments such as a purchase or sale of an asset.
Cash from financing activities includes the sources of cash from investors or banks, as well as the uses of cash paid to shareholders. The payment of dividends, the payments for stock repurchases, and the repayment of debt principal (loans) are included in this category.
Example of Company Appropriations
Below is the cash flow statement for Exxon Mobil Corporation (XOM) from Sept 30, 2018, as reported in its 10Q filing. The cash flow statement shows how the executive management of Exxon appropriated the company’s cash and profits:
Under the investing activities section (highlighted in red), $13.48 billion was allocated to purchase fixed assets or property, plant, and equipment.
Under the financing activities section (highlighted in green), cash was allocated to pay down short-term debt in the amount of $4.279 billion.
Also under financing activities, dividends were paid to shareholders (highlighted in blue), which totaled $10.296 billion.
Exxon Mobil cash flow statement 09-30-2018. Investopedia
Whether Exxon’s use of cash is effective or not is up to investors and analysts to debate since evaluating the process of appropriating cash is highly subjective. Some investors might want more money allocated to dividends while other investors might want Exxon to allocate money towards investing in the future of the company by purchasing and upgrading equipment.
Appropriations vs. Appropriated Retained Earnings
Appropriated retained earnings are retained earnings (RE) that are specified by the board of directors for a particular use. Retained earnings are the amount of profit left over after a company has paid out dividends. Retained earnings accumulate over time similar to a savings account whereby the funds are used at a later date.
Appropriated retained earnings can be used for many purposes, including acquisitions, debt reduction, stock buybacks, and R&D. There may be more than one appropriated retained earnings accounts simultaneously. Typically, appropriated retained earnings are used only to indicate to outsiders the intention of management to use the funds for some purpose. Appropriation is the use of cash by a company showing how money is allocated and appropriated retained earnings outlines the specific use of that cash by the board of directors.
Limitations of an Appropriation
For investors, the cash flow statement reflects a company’s financial health since typically the more cash that’s available for business operations, the better. However, there are limitations to analyzing how money is spent. An investor won’t know if the purchase of a fixed asset, for example, is a good decision until the company begins to generate revenue from the asset.
As a result, the investor can only infer whether the management is effectively deploying or appropriating its funds properly. Sometimes a negative cash flow results from a company’s growth strategy in the form of expanding its operations.
By studying how a company allocates its spending and uses its cash, an investor can get a clear picture of how much cash a company generates and gain a solid understanding of the financial well being of a company.
