What Is ROAS? How To Calculate Return on Ad Spend
February 7, 2020
Return on ad spend (ROAS) is a type of return on investment (ROI) that serves as an essential indicator of the success of your marketing and advertising expenses. In the simplest terms, it shows how much you earned through your ad spending.
But ROAS can be a little complicated to calculate, especially if you’re using different platforms and running several campaigns. It’s not just about the big picture stuff but also the devil in details — such as pricing products or dollars spent on advertising campaigns. You’ll need to understand it all to winnow out which marketing channels work and which don’t.
This article will explain why ROAS is important and show you how to calculate it accurately. You’ll also learn what your goals should be with advertising and marketing expenditures.
What Is ROAS?
Return on ad spend (ROAS) is a measure of dollars made for every dollar spent on advertising. Simply put, it’s the return of advertising expenditures.
As mentioned before, it’s essentially an ROI, and in many ways, also a key performance indicator (KPI). It puts a numeric value on your marketing efforts and makes them measurable. More return on ad spending means you’re doing something right, whereas less return on ad spending means there’s something wrong you need to fix.
It offers flexibility to calculate the return for different kinds of marketing campaigns for various niches, regardless of the industry.
Let’s get to business with the formula for calculating your return on ad spend. You can calculate it in two ways:
- Revenue / Cost: This formula is relatively simple. You divide the revenue by the advertisement cost — including the marketing campaign, campaign managers, affiliate commissions, campaign designers, and others. While it will tell you exactly how many dollars you made per dollar spent on a campaign, it doesn’t net in the costs related to your product or service.
- (Revenue – Cost) / Cost: The formula above doesn’t account for all the cash you’ll pay for advertisements. So to gauge the real numbers factoring in costs, you can use this formula. You deduct the advertisement cost from the revenue and then further divide the result by the cost of advertising and marketing.
Here’s an example of each ROAS formula at work, supposing you spent $100 on an advertisement and generated a revenue of $200:
- The first ROAS formula shows that you made $2 per $1 spent on ads. Here’s the calculation: $200 / $100 = $2
- The second ROAS formula shows that you’ve earned an extra $1 on every $1 spent on ads. Here’s the calculation: ($200 – $100) / $100
The second ROAS formula indicates a break-even situation — but that’s not the case, as we’ll shortly discuss.
For a more straightforward calculation, the first formula is better. But you can use any of the two to get a sense of where your ad campaigns are going. At the very least, both of these formulas will tell you if you’re making a profit or going in loss with your ad spending.
Thanks to built-in analytics on many tools and platforms, ad revenue calculation and tracking are happening at all times. This is helpful because you get the data while the campaign is running, not just at the end of it. Some campaigns may run for weeks, so you need to track the ROAS continuously.
For instance, Google Ads allows you to track conversions for a given campaign, specifying which ad, ad group, or keyword has generated conversions, and ultimately, revenue. In most cases, especially with e-commerce stores, this is calculated by tracking clicks.
For ecommerce marketing, the relation between ad spending and revenue is pretty direct. However, for other niches, things can be a little tricky. The difference comes down to conversions and sales, so let’s talk about both.
For most businesses, especially non-ecommerce ones, conversions indicate revenue. For campaigns run on Google, Bing, Facebook, Instagram, or Twitter, conversions are easier to track with the help of built-in analytics. On the other hand, a company tracking conversions from phone calls or emails may have to use an independent tool to calculate conversions, such as a call tracking platform.
It’s all about using the right tools for every medium, be it social media, web, phone, or email. You’ll need to track conversions on each to get a sense of the total revenue generated from different advertising and marketing channels.
In comparison with conversions, tracking sales is a bit easier. Many sales software — for example, Salesforce, Copper, or Zoho — integrate with advertising platforms to calculate ad revenue as per the sales.
The key here is using reliable customer relationship management (CRM) software. It can even track a lead to a marketing campaign when it becomes a paying customer. This way, even non-ecommerce businesses, such as subscription model businesses, can calculate ROAS.
Why Use ROAS?
You’re already spending money, time, and effort on ads. Why spend more on calculating and tracking ROAS? Why not just track click-through or conversion rate to see how your ads are performing? The thing is that click-through rate or conversion rate may not tell you how much money you made from ads. Remember that the goal is to make more revenue.
Companies spend thousands of dollars on online ad campaigns, but if they are not augmenting sales and revenue, all that money is going to waste. It’s one thing to spend money, it’s another to get the most value out of it, and that’s what ROAS offers.
To understand the benefits of measuring returns on ads, let’s see what clicks, conversions, and ROAS tells you about your campaigns.
What Does Click Data Tell You?
Suppose you’re a partner in the ABC law firm. Each new customer averages $3,500 in revenue with a 50% profit margin, making net profit $1,750.
The data for the most successful campaigns is as follows:
As you can see, Campaign 3 seems to be producing the best results, as it has the lowest cost per click (CPC) paired with the highest click-through rate (CTR).
But what about the end result of those clicks? Where are these clicks coming from and are they converting? It could be true that the clicks are coming from people just browsing for ‘lawyer firms near me’ or ‘lawyer jokes.’ They may click through, but these people won’t actually hire a lawyer from your firm.
What Does Conversion Data Tell You?
Now, you’re probably thinking conversion rate (CR) would be a much better measure for ad success, at least more so than click rate. Let’s see if that’s the case and look at the conversion data below:
Again, Campaign 3 looks like a clear winner when considering CR. While the CR is lower than Campaign 1, 4, and 5, the cost per lead (CPL) is the lowest. On the other hand, Campaign 4 is coming in at last as it’s costing nine times more than Campaign 3 for producing the same number of leads.
But why is Campaign 3 producing lower CR, nearly by half, than Campaign 1? Could the ads be going to an irrelevant audience? Do you have a poor landing page or could the overall traffic be low? You see a lot of questions go answered even when you track conversion rate exclusively.
What Does ROAS Data Tell You?
Let’s look at the ROAS now:
Now, the story is a little different. You can clearly see that Campaign 4 is making the most money for the company, despite showing weak numbers for clicks and conversion. In hindsight, Campaign 3, despite winning clicks and conversion, seems to be having the lowest ROAS and making the second-worst revenue.
But here’s the real twist. As fulfillment accounts for nearly half the revenue, Campaign 3 is actually losing money.
With a ROAS of 92%, it’s resulting in a loss for the law firm. Campaign 4, on the other hand, is making good money, profiting the company even after adjusting the costs. There could be many reasons for this scenario, advantaging Campaign 4:
- Traffic in the lower stage of the sales funnel
- Better landing page
- Relevant searches
By now, you can see why ROAS is important. If it weren’t for this metric, you’d continue spending more on Campaign 3, resulting in even more losses.
What Makes a Good ROAS?
Suppose you’re a small-scale aerial tours company providing aerial tours of Bryce Canyon in Utah. One plane seats only one passenger, and the price is set at $150. Even without marketing, you’re netting 20 ticket sales per month through direct sales, referrals, and repeat customers. Your revenue from this particular tour comes to $3,000 per month. Each flight costs $75, which means revenue, when adjusted for the cost, comes down to $1,500. Other fixed costs set you back another $2,000. Therefore, you’re losing $500 every month.
You decide to advertise. Here are what different ROAS numbers — calculated with the second formula — mean for your campaign:
If you made $150 after spending $150 on advertisements, you didn’t break even, at least not in this scenario. You still need to make the $500 deficit, which you only can with profit. The following chart demonstrates that. You’re still losing $75 in fulfillment costs for every sale.
Consider a 2:1 ratio, where you’re spending $75 and making $150. It’s an improvement but still not enough to make that glaring deficit of $500, contributed by fixed costs of the business. In scenarios where you’re in a deficit, even a slight profit from every dollar spent may not be enough. .
So you spend $50 and make $150 from your advertisement per sale? Indeed, that should be a positive outcome. With a 3:1 ratio, you’ll finally break even, provided you’re getting at least 20 sales from advertising and marketing. Your advertising efforts are working, but you’ll make the deficit rather slowly. You also have to take into account logistical limitations, like the possibility of scheduling only 40 flights in a month.
With a 4:1 revenue to ad spending ratio, you’re nearing the target of clearing the deficit and making a profit. After 14 flights are generated from the ads, you’ll cover the costs. With a profit of $37.5 per flight, the ads will finally prove profitable.
In the current example of the aerial tour company, a ROAS of 5:1 is ideal and puts the company in a strong position. Not only does it cover the costs, but it also nets a profit of $405 per month with 9 of the 20 sales. With these profits, your business can start to grow, like searching for a better and bigger plane and increased capacity per flight. These measures can only be taken when you’re running in profit.
The Bottom Line
Here’s what ROAS comes down to, as illustrated by the example above:
- If your ROAS is 3X or lower, you need to improve your digital marketing game, as you’re likely losing more money than gaining.
- Your target should be 5:1 ROAS, especially with the latest techniques like automated bidding, but 4:1 ROAS is also good.
- Whether ROAS is good or bad also depends on your revenue and costs.
ROAS is downright one of the best metrics to measure the success and effectiveness of your advertising efforts and marketing strategy. The more revenue they generate after factoring in fulfillment and fixed costs, the better the outcome of running ads is.
If you need help calculating ROAS for your specific business, feel free to let us know.
What do you think about ROAS? Has it helped your business in any way? Share in the comments!