You ever think, “How much should i spend on marketing?” No one knows intuitively how much to spend on marketing their business.

At first, many small businesses rely on networking and word of mouth to win clients. And that might be enough to keep a business going, at least for a while. But there often comes a point when a business owner wants to expand, and free marketing isn’t going to cut it anymore.

A CEO might know what kind of advertising to invest in, depending on the habits and interests of their potential customers, but they probably don’t know what percentage of their profits to spend on marketing to attract more business. And they certainly won’t be able to site a precise price range.

Don’t forget to include rent

According to Entrepreneur.com, there is a formula that uses your projected gross annual profit and your rent to figure out what you should spend.

Why include rent? Why not just use the “five to eight percent of your gross sales” that most marketing agencies will tell you?

This is because where you are located is its own advertising. If you pay a lot for rent — say, $100,000 per year — then you may well be in a great location. People will see your company name all the time and you’re more likely to be top-of-mind in mental searches for products like yours. If your business is set up in an out-of-the-way spot — such as in your home (zero visibility), then you should be spending more on marketing to make up for the fact you have no visibility on the street.

The formula

First, you calculate the low end and the high end of what you should be spending. These two numbers are 10 and 12 percent of your projected annual gross sales. That’s not so hard — if you predict you’ll make $1 million, then 10 percent is $100,000, and 12 percent is $120,000.

Next, you multiply each of these two numbers by the markup you earn on the average transaction. This means gross markup above cost, expressed as a percentage of cost. So if you spend $100 on each widget but sell them for $150, your markup is 33 percent. (Your margin is $50, which is the number most business owners focus on.)

Next, you divide the gross profits by cost. Using the example above, your gross profits are $333,000, which you would divide by $666,000 (the amount you spend to buy or create the widgets you’re selling.) This leaves you with “0.5” on the calculator, or 50 percent. This means that your 33 percent margin represents a markup of 50 percent.

Then you multiply the markup percentage by $100,000 and $120,000, which gives you $50,000 and $60,000. From there, you subtract what you pay on a year in rent (say $25,000) leaving you with your final spending range of between $25,000 and $35,000 on marketing.

Another example

Let’s try the same calculation with less straightforward numbers.

You expect to make $2.5 million in the next year. Each widget you sell costs you $25 to manufacture. You sell each widget for $55.

Step one: Calculate 10 and 12 percent of your projected gross profit: 10 percent of $2.5 million is $250,000, and 12 percent is $300,000.

Step two: Determine your average markup percentage on each widget, and multiply it by $250,000 and $300,000: Your profit margin of $30 on each widget represents a 54.5% markup (rounded). So 54.5% of $250,000 is $136,250 at the lower end of the range and $163,500 at the higher end.

But that’s not taking your rent into account. To get to the final budget range, you subtract your annual rent from both numbers. So if your rent is $45,000, the range you should be spending on marketing is between $91,250 and $118,500.

How to split up your marketing budget

There are less hard and fast rules on how to split up your marketing budget. Business owners tend to know best what the behaviours of their potential customers are, and where they are most likely to see ads.

But even though knowing your customer makes a big difference, there are also helpful statistics out there about where the average business is spending its marketing dollars. Not surprisingly, digital marketing continues to grow. By 2020, people are expected to spend more time on their mobile devices than watching TV.

Research from Forrester and eMarketer predicts these spending patterns into 2021, which might be helpful as you split your marketing budget up.

Right now in 2018, the average business spends 41 percent of its marketing budget on digital marketing (such as PPC and SEO) and by the year 2020, it will grow to 45 percent. Most of this will go toward search engine marketing efforts (buying ads from Google AdWords being the most popular), followed by online display ads, such as online video and banner ads. Factoring in SEO cost is also important.

When compared to 2016 statistics, investment in online video marketing will double by 2021. Social media will climb as well, with a mean annual growth rate of 17 percent up to 2021, and is about 25 percent of all online marketing budgets in 2018.

By 2021, almost half of all advertising costs will go towards e-mail marketing, online video ads, social media ads, display ads and paid search ads.

How does your marketing budget measure up?