Whether you’re at the beginning of your ROAS journey or you’ve been at it for years, you need to know your numbers to make the dream come true.
Numbers (especially ratios) show whether your store is making money and if it’s not, how to fix it. If you pay for advertising to get traffic to your store, the most important indicator you can focus on is Return on Ad Spend (ROAS). This guide will help you understand not only what ROAS is and how to calculate it, but how to know if yours is any good. Let’s get to it.
ROAS, ROAS, on the wall, are my ads making me money, at all?
If e-commerce ratios are a Magic 8 Ball, ROAS is the little floating message that pops up when you ask if your ads are making money. Simply put, ROAS is calculated like this:
ROAS = Sales / Ad Spend
The number you get (let’s say 2.45) means you made that many dollars back ($2.45) for every $1.00 you spent on ads. If your ROAS is at least 1.00, you know you made enough in revenue to pay for the ads themselves, so technically, that’s good.
But what about the costs of producing and shipping the product? If your ROAS is 1.00, that means you haven’t made enough from your ads to pay for these extra costs, which we’ll refer to as the Cost of Goods Sold (COGS). This means that you’re still losing money. So how do you know what ROAS to shoot for? Enter Breakeven ROAS.
Breakeven ROAS: The Ultimate Measuring Stick
We love analogies, don’t we? In this one, I take you to the amusement park of your dreams. The most fun ride in this amusement park is called Profitable Store (maybe get a little more creative with your dream names), and there’s a measuring stick at the entrance with a little mark that reads “Must Have This ROAS to Ride.” All your hopes of getting on that ride come down to one little mark, and that mark is Breakeven ROAS.
Here’s a shortcut for calculating Breakeven ROAS. If you’re interested in going deeper, stick around and we’ll talk nitty gritties.
Breakeven ROAS = 1 / Profit Margin,
where Profit Margin = Profit per sale / Revenue per sale
As an example, let’s say I sell t-shirts for $20 each, and it costs me $6 to make and ship each shirt (COGS). Here’s what the Breakeven ROAS calculation would look like:
Revenue per sale = $20
COGS = $6
Profit per sale = $20 – $6 = $14
Profit Margin = $14 / $20 = 70%
Breakeven ROAS = 1 / 70% = 1.43
What do I learn from this? I learn that once my ads are getting 1.43 ROAS, they pay not only for themselves but my COGS as well. This means anything above 1.43 ROAS is pure profit! Now I can understand whether my ROAS is good or bad (profitable or unprofitable).
NOTE: Once you figure out your Breakeven ROAS and decide whether your current ROAS is profitable, you’ve only just started the journey of analyzing your store’s performance. To keep digging deeper, check out our Ecom Diagnostic Guide and infographic, which will give you a step-by-step guide on how to improve your metrics that affect ROAS.
Can I change my Breakeven ROAS?
Knowing your Breakeven ROAS is important because it’ll help you know whether your ads are profitable. But what if you’re not profitable? Can you change your Breakeven ROAS? The short answer: yes. The reality: it’s difficult.
To see why let’s consider the formula: Breakeven ROAS = 1 / Profit Margin. Breakeven ROAS and profit margin have what is called an inverse relationship. That is, as one goes up, the other goes down. The higher your profit margin, the lower your Breakeven ROAS. So if you want a lower Breakeven ROAS, you need a higher profit margin!
To increase your profit margin, you can increase your revenue per sale or decrease your COGS. Decreasing COGS can be challenging, so make sure you’re negotiating the best pricing possible from your supplier and take advantage of quantity discounts when you can.
Revenue per sale is a direct result of price, so make sure that you have the right mix of price and conversion rate to maximize your profitability. Play around with the pricing until you get it right. By experimenting, you’ll find the sweet spot for your business.
The Weeds: How we got there
If you’re like us, you need to understand how things work beyond just the formula – you want to understand why it’s true! Going deeper into where we get these numbers and ratios gives us intuition about them. Not like a creepy, ESP kind of intuition, but a deep understanding of where the metrics come from, starting from a place we already understand.
An intuitive way to think of Breakeven ROAS is that it needs to be at least 1.00 (to pay for the ads themselves) plus some additional amount to pay for COGS. To break even, we will need to pay for COGS by spending no more on advertising than the profits we will make, so the extra ROAS will need to equal (COGS / Profit per sale). If we write that out, we get
Breakeven ROAS = 1.00 + (COGS / Profit per sale)
We can replace 1.00 with (Profit per sale / Profit per sale), and combine the terms to get Breakeven ROAS = (Profit per sale + COGS) / Profit per sale
Then if we recognize that (Profit per sale + COGS) = Revenue per sale, we get Breakeven ROAS = Revenue per sale / Profit per sale
Which is the inverse of the equation for Profit Margin, or
Breakeven ROAS = 1 / Profit Margin
That was a lot of math for a marketing blog, but it is SO important to understand where metrics come from and what they mean. We hope that explanation helps you gain some intuition around Breakeven ROAS.
To be successful, you gotta know your numbers. It’s easy to get lost in the day-to-day, shooting from the hip and putting out fires instead of focusing on what matters. Breakeven ROAS helps you step back and see if your efforts are getting you ahead or putting you in the hole.
One more thing. We know that the numbers and analytics of marketing can be overwhelming, and we’re here to help. At Scroll, we eat, sleep, and breathe this stuff so you don’t have to. If you’d like us to take the reins, shoot us a message at firstname.lastname@example.org.