Financial ratios are numerical values that calculate the relative magnitude of one financial figure to another. Usually, it looks at the comparison between two financial items. These items may relate to the balance sheet or income statement. In some instances, they may also consider the statement of cash flow figures. However, these ratios reveal more information about a company’s operations than those figures do.
Financial ratios, also known as accounting ratios, are crucial for stakeholders. Usually, these provide them more information about several business areas with a company. For example, they may determine how efficient the company is in the use of resources. Other financial ratios may measure profitability, liquidity, performance, or leverage. These ratios cater to all stakeholders that can base their relationship with a company based on them.
Overall, financial ratios help stakeholders understand financial statements and give them an insider view. These ratios help perform quantitative analysis and assess various aspects of a company’s operations. Among these, performance ratios can be crucial in gauging efficiency and effectiveness. One of the metrics included among those ratios consists of the advertising to sales ratio. Before understanding that, however, it is crucial to know what performance ratios are.
What Are Performance Ratios?
Performance ratios measure a company’s ability to use its assets and manage its liabilities effectively. These ratios, also known as efficiency ratios, look at how effectively a company utilizes its resources. Companies calculate performance ratios at regular intervals to assess how well they manage their assets and liabilities. Similarly, it helps gauge their performance over time.
Performance ratios can help measure two aspects of a company’s business. The first involves measuring how efficiently and effectively a company uses its resources to generate sales. In contrast, the second includes establishing the growth of shareholders’ wealth. In essence, performance ratios focus more on a company’s performance than other aspects, for example, cash flows or financial position.
Performance ratios usually measure a financial metric against a company’s sales. Therefore, these ratios gauge how a company uses its financial resources to generate income. Another name used for these ratios includes activity ratios. These ratios usually examine the short-term or current performance that results from a company’s operations. These require current assets or current liabilities. Therefore, they also consider short-term financial resources indirectly.
While performance ratios are crucial for stakeholders, they can also be beneficial internally. A company’s management can use these ratios to understand how their operations impact their revenues. Usually, companies use these ratios to measure performance with historical numbers. However, stakeholders may use it to compare operations with the industrial average or competitors.
In general, performance ratios gauge a company’s short-term or current performance. Usually, these ratios compare a company’s expenses to its sales. However, these items require current assets and current liabilities. By doing so, performance ratios also consider how companies use their financial resources. One of these ratios includes the advertising to sales ratio, which can be highly beneficial to calculate.
What Is the Advertising to Sales Ratio?
The advertising to sales ratio is a measure of how a company’s advertising campaign performs. Usually, advertising includes expenses on an advertising plan. This plan encompasses various factors, such as its advertising goals, sales targets, competitive situation, marketing information, etc. In essence, the advertising to sales ratio measures how effective a company’s advertising expenses is in generating sales.
The advertising to sales ratio can provide beneficial information about how much advertising expenses contribute to sales. When companies spend on promotional activities, they require a return in the future. However, it is not possible to gauge its effectiveness in the same period. Usually, it needs some time to reach the right audience and have an impact.
Therefore, the advertising to sales ratio measures how advertising expenses impact sales. In essence, it considers the quantities of resources invested in advertising campaigns. It looks at those resources in contrast to the amount of new business they helped generate as a direct result. Therefore, the advertising to sales ratio helps gauge whether spending on advertising helped generate new sales.
Another name used for the advertising to sales ratio is “A to S”. It takes total advertising expenses and divides them by sales revenues. Consequently, this ratio demonstrates whether money spent on the advertising campaigns helped promote its products or services. However, there is no fixed measure of how much this ratio should be for companies to consider their campaigns successful.
Overall, the advertising to sales ratio measures whether spending on advertising helped generate new sales. This way, companies can determine whether advertising campaigns were successful in helping promote products or services. Stakeholders can also use this ratio to understand whether a company ran a successful marketing campaign. On top of that, they can use it comparatively to get even better insights into those operations.
How to Calculate the Advertising to Sales ratio?
Calculating the advertising to sales ratio is straightforward. As mentioned, this ratio is the comparison of a company’s advertising expense to its sales. Through this definition, it is possible to understand how companies can measure this ratio. Usually, stakeholders can use the following formula for the advertising to sales ratio.
Advertising to sales ratio = Total advertising expenses / Net sales
In the above formula, the total advertising expenses are the amount of money spent on advertising. Usually, this figure is available in the income statement or the notes to the financial statements. In contrast, net sales represent the incomes generated by a company for a period. This figure is also available in the income statement.
How to Interpret the Advertising to Sales Ratio?
The denominator for the advertising sales ratio is a company’s sales. Therefore, the higher these sales are, the lower this ratio will be. Similarly, lower net sales mean the advertising to sales ratio will also be below. On the other hand, the numerator includes the total advertising expenses. The higher this figure is, the higher this ratio will be. If it is low, this ratio will be low as well.
Overall, the lower the advertising to sales ratio is, the more preferable it is. A lower figure implies that the company generated high revenues from its advertising campaigns. It also suggests that for every dollar spent on advertising expenses, the company made significantly higher sales. However, this interpretation is subject to some conditions.
The advertising to sales ratio does not provide beneficial information about a company’s operations. Therefore, stakeholders must view this ratio comparatively to receive better information. This process may require comparing this ratio to competitors, industrial average or even historical performances. This way, stakeholders can understand how the company has fared when it comes to advertising campaigns.
Overall, interpreting the advertising to sales ratio is straightforward. This ratio represents the magnitude of sales that advertising expenses form. Therefore, the lower it is, the higher sales a company generates per unit of spending on advertisement. However, it is crucial to view this ratio comparatively rather than interpret it on its own. This way, stakeholders can get better information.
Example
A company, ABC Co., ran several advertising campaigns during a calendar year. During this period, the company spend a total of $250,000 on advertising expenses. ABC Co. also generated total sales of $10 million during the period. Therefore, the company’s advertising to sales ratio was as follows.
Advertising to sales ratio = Total advertising expenses / Net sales
Advertising to sales ratio = $250,000 / $10,000,000
Advertising to sales ratio = 0.025
The above ratio implies that the company only spent $0.025 per $1 generated in sales. However, it does not provide further information about how successful the company was. Since the advertising to sales ratio differs from one industry to another, it is crucial to view it comparatively. Once stakeholders compare it with the industrial average or competitors, they can get better insights into ABC Co.’s operations.
Conclusion
Performance ratios measure how effectively and efficiently companies use their resources to generate sales. One of these ratios includes the advertising to sales ratio, which gauges advertising expenses against revenues. Usually, stakeholders prefer this ratio to be lower. However, it may differ from one industry to another.
