When we think about advertising, images of billboards, pamphlets, television, and newspapers come to our minds.For brands, the motive with advertisements is to attract attention from potential customers and increase its sales by maintaining a good reputation. Apart from this, many companies use advertising methods to create and maintain awareness about various social issues.
1. How do Brands Advertise about their Product?
Advertising can be done in two ways. Firstly, traditional advertising involves displaying advertisements on television, radio, or print them. This is a very easy way to get new customers. The other one is digital advertising which is becoming a more convenient choice for companies as more and more customers are using digital media.
For advertising their products or services, the companies hire an agency that specifically works in the field of advertisements.
These advertising costs are broadly categorized into categories: Fixed cost and Variable cost. So now the question comes: where to put these costs on the balance sheet of a company?
To adhere to this question, let’s know about what is the difference between these business costs.
2. What Do You Mean by Fixed Costs?
The term “fixed” means having a predetermined value that doesn’t change over some time. Similarly, fixed costs are those which are incurred by a company over a specific duration and are not subject to change regardless of the level of output. For example, a business owner has to pay a fixed rent to the landowner, say, annually for using the land even if the production is low. Hence, we can say that fixed costs can be recurring in nature. Insurance, interest payments, wages, and salaries are some other examples of fixed costs.
2.1) Average Fixed Costs
As total fixed costs are those which are spent in fixed quantity over a particular period, average fixed costs are the total fixed cost per unit of output produced. Unlike the total fixed costs, this changes with the production levels. For example, if the output increases, the average fixed cost will decrease as now less fixed expense is divided because of the new unit sold.
Average Fixed Cost = (Total Fixed Cost) / ( Total Production)
According to the Business Dictionary, “Companies with high fixed costs need to produce more to break even (a point at which total revenue equals total cost) but they also have higher profit margins than companies with high variable costs.”
This means that as the company has fixed its cost at a high level, it now needs to produce more to offset the gap between revenue and costs.
3. What Are Variable Costs?
Variable costs are those which depend upon the level of output and revenue of a company. If, say, the revenue generated is less for a given month, the company will cut down on its variable costs for the next month. These cost changes can vary from high to low based on the production level. Some of the variable costs are raw materials, shipping charges, and commissions.
3.1) Average Variable Cost
Total variable cost is the sum of the variable costs of every unit you produce, whereas average variable cost is the total variable cost per unit. Using both total cost and average variable cost, the company can predict changes based on increasing/decreasing production volume.
Average Variable Cost = (Total Variable Cost) / ( Total Production)
As the Business Dictionary says, “Companies with high variable costs need to produce less to break even but they also have lower profit margins than companies with high fixed costs.”
To reach the break-even point, the high variable cost companies need to produce less as they can adjust their costs in time with their production process.
4. Total Costs of a Company
Adding both the costs, that is, total fixed cost and total variable cost, we get the total costs incurred by the business owner. We can say that both these costs are an element of the total costs.
Total Costs (TC) = Total Fixed Costs (TFC) + Total Variable Costs (TVC)
After knowing about both types of cost, we can say that advertising can fall into both categories depending on the company’s approach.
5. Advertising as a Fixed Cost
For every business year, each company drafts its annual budget assigning the money to spend in different fields. The items included in an annual budget serve as another example because budget allocations typically don’t change until the next planning cycle.
So, if the company has signed a year-long or long-term contract with an advertising agency, then it will set a separate advertising budget. In this case, advertising is treated as a fixed cost as it remains constant for that particular period.
5.1) Marketing vs Advertising
In layman’s language, marketing is a process in which a company does research about how to meet consumers’ needs. On the other hand, advertising is the implementation of this marketing research by promoting the company’s goods or services. Hence, we can say that advertising is one element of marketing amongst others.
Now, for a business, marketing is a major expense in both small business budgets and established businesses. Once you make a marketing budget allocation, it becomes a fixed expense because it typically does not change over the coming year.
Therefore, as advertising is considered a part of marketing strategy, companies tend to fix either a separate budget for advertising or a certain section in their fixed marketing budget.
5.1.1) Advertising Budget Allocations
This advertising budget will include both traditional and digital advertising. Based on this year’s budget, the company will increase or decrease next year’s fixed advertising budget. But generally, the companies know how much the cost will add up in a year and hence form their budget accordingly. Mostly, this change in the predetermined fixed cost does depend on the expected sales and output production of the next planning cycle.
Fixed-cost advertising examples include purchasing billboards or spaces in newspapers and buying a specific air-timing on televisions or radio.
6. Advertising as Variable Cost
Let’s say there is a small company considering its advertising costs. Plus, they don’t have enough knowledge about their future sales and also can’t spend money on a random basis. In this particular case, the company will categorize its advertising costs as a variable. The advertising expenditure will depend upon the level of sales and production of the company. As and when the sales increase, the company will set more funds for advertising.
Not only that but when there are seasonal variations, the market demand and supply change. To accommodate these changes, the business owner will cut down or pull up their variable expenses for advertising. One example to understand this is to consider an umbrella company. It will spend more on its advertising during the monsoon season compared to the winter season as there will be a revenue surge in the monsoon season.
One of the most known variable cost advertising is pay-per-click (PPC) advertising. In this, the advertiser is charged when a user clicks on their advertisement. Cost-per-action(CPA) and cost-per-impressions(CPM) are some other variable-cost advertising.
But how should an owner outlay his firm’s advertising budget? To know about it let’s go through the factors influencing the budget of advertisement.
7. Factors Affecting the Advertising Budget
Information about the affecting factors is important to get a successful advertising strategy. Some of the necessary factors to see through are:
7.1) The Firm’s Present Market Share
The market share of a firm decides the amount of promotional money needed. If a firm has a lower share, it needs to spend more as compared to firms having a larger share.
7.2) Degree of Competitiveness in the Market
Many big firms increase their competitiveness in the market. So having similar products will require a heavy budget to get noticed by the customers.
7.3) The Product Life Cycle
If a new firm has entered a market it has to strategize its budget to spread its name to attract customers. Hence, they have to allocate more budget in their initial growth stage. However, with time, this cost will decrease as the name of the firm becomes well-known.
7.4) Frequency of Advertisement
The budget will depend on how many times a form wants to run its advertisements. The more the number of runs, the more the allocated budget.
8. Advertising and SG&A Expenditure
As intimidating as this SG&A abbreviation looks, it’s quite a simple one that stands for sales, general and administrative. SG&A expenditure comprises all the direct, indirect, and residual expenses which are necessary to run a company. It’s kind of a miscellaneous category that includes the expenses incurred daily as well as those which are not directly related to the production process.
It should be known that advertising expenses on an income statement are generally grouped into SG&A expenditures.
9.“Mixed” Advertising Cost
These days, many business owners are likely to adopt a fusion of fixed and variable advertising costs. Knowing how to classify and work with information about fixed and variable costs is as helpful for small businesses as it is for well-established businesses. Classifying fixed and variable expenses and putting them in the correct category is the first step in performing a periodic break-even analysis and budgeting. This knowledge about advertising expenses and production can help a business owner to minimize costs and improve their business.
Depending on the result of effective advertising, a company can internalize the advertising costs as assets or liabilities.
Advertising can either be fixed or variable costs depending on the approach used by the company to fulfil its future goals. It also depends upon the geographical and the targeted sections of the society as well as the seasonal variations.