Whether it’s digital advertising or email campaigns or SEO-driven content, marketing costs money. That’s why it’s not surprising tons of companies consider a marketing budget as a cost center of a business rather than a quantifiable and predictable investment in a company’s growth. But that’s a mistake.
The trick is to get the right economics that will allow you to acquire as many profitable customers as possible regardless of any financial period. This will help you to get through hard times and unleash your profitable growth. The best way to do this is to start creating solid, efficient marketing P&L statements.
In this guide, we’ll cover everything you need to know to get started, including:
- What a marketing P&L is
- Why a marketing P&L is important for your business
- Why a marketing P&L beats a marketing budget
What is a Marketing P&L?
A marketing P&L is a statement that summarizes the costs associated with marketing initiatives.
The best way to understand a marketing P&L is to start with a typical, company-level profit and loss statement. The profit and loss, or P&L, statement is a financial statement that summarizes the revenues, costs, and expenses incurred during a specified period, usually a fiscal quarter or year. The P&L statement is synonymous with the income statement. These records provide information about a company's ability or inability to generate profit by increasing revenue, reducing costs, or both.
A marketing P&L doesn’t differ much from a traditional P&L. It is comprised of the same set of line items, like:
- Cost of sales
- Gross profit
- Gross margin
- Operating expenses
- Operating profit margin
Now, the difference is that in a marketing P&L, we need to track a number of sub-metrics that helps us further grasp how well we are doing with our marketing initiatives.
- Gross profit per user
- Customer acquisition cost
- Customer lifetime value
- Payback period
- Gross profit per cohort
- Annual revenue per user
Now that we know what a marketing P&L is — and what the report includes — let’s talk about why it’s so important.
Why is a Marketing P&L Important?
Your marketing P&L statement will give you a full picture of the costs incurred for marketing initiatives—and it can help you identify areas for growth.
Your company’s P&L report gives an insight into your company’s performance and helps you understand your financial position and underlying profitability. It helps you break down your revenues and expenses, so you can understand exactly how much you are making on your various products and services, and which products provide the best gross margins.
You can calculate your gross margins by deducting the cost of goods sold (COGS) from revenue to get your gross profit. Then, take your gross profit and divide it by your revenue. This metric is super important, as it determines how much you can spend on other operating expenses like salary, marketing, equipment and so on to achieve profitability.
Calculating your gross margins works exactly the same way for your marketing P&L as it does for your regular P&L. That means, in theory, the higher your gross margins, the more you can spend on marketing.
Why Does a Marketing P&L Trump a Marketing Budget?
Tons of companies set a marketing budget, typically where the C-Suite agrees on a predetermined budget to spend on marketing in a given period of time, often a quarter or a year. After that, the leader or leaders of the marketing team sit down and agree on a set of channels to spend the money on. Typically, a marketing budget looks something like this:
Total Budget for Q2: $200,000
- Ad Spend: $50,000
- Performance: $50,000
- Influencers: $50,000
- Conferences: $50,000
Now, the problem with this type of marketing budget is that it doesn’t reflect the return on investment, or ROI. It doesn't show how the marketing spend actually drives value to the overall company P&L. It’s surprising how many marketers don’t know what returns their investments drive.
That’s why a marketing P&L is so much better for your business. A marketing P&L helps you drive profitable growth, where you can clearly see the impact that every marketing dollar spent drives on your revenues and gross profits. It’s extremely important for businesses to ensure that the CMO or marketing director can run their own P&L and understands how their investments impact the business as a whole.
So How Does It All Come Together? That Brings Me to My Next Point.
How to Set up a Marketing P&L
Note that there are multiple ways you can set up your own marketing P&L, but this has proved to be working for me while being in charge of marketing at different startups.
To illustrate the example in greater detail, feel free to check out the marketing P&L spreadsheet we prepared for you. This framework provides a model for where you can calculate and understand your marketing P&L and how you performed in a given period of time. We break it down below.
First, the BLUE cells are input cells, meaning that you can enter your own data here. Please feel free to make a copy of this spreadsheet. The rest are formulas and can’t be edited.
- Marketing spend: Here you can insert how much you spent on marketing in a given period.
- Revenue: Here you can insert how much revenue you made from that marketing investment in a given period.
- COGS: Here you input the total COGS you incurred by selling these items. This is typically done by saying (COGS per product * products sold = total COGS).
- Gross profit, excluding marketing spend: This is a function of (revenue - COGS).
- Gross profit, including marketing spend: This is a function of (revenue - COGS - Marketing Spend).
Alright, now you understand your gross profit (both including and excluding marketing spend). Note, that in a traditional overall company P&L, the marketing spend would normally be considered operating expenses, but since we are making a dedicated marketing P&L, we have re-structured it slightly. Let’s move down to the more advanced metrics.
- New customers: Pretty simple, insert the number of new customers you generated through this period.
- CAC: This is your customer acquisition cost, so how much did you spend to acquire each customer. This is calculated like this: total marketing spend / no. of new customers.
- Payback period: This one is important as it impacts your cash flow a lot! Here's how to calculate this: gross profit ex-marketing spend / marketing spend. You'll get the number of months of your payback period. Effectively what you want to understand is how long it takes for you to break even on your marketing investment back into your pocket. So to simplify it, if you invested $100 and you got $20 back per month, it would mean that your payback period was 5 months, because ($20/$100 = 5).
- Gross profit per user: Another important metric: total gross profit / no. of new customers. Effectively, you want to understand your profit per user.
- Predicted LTV: Note that we are calling it “Predicted LTV” and not pure LTV. We will talk more about LTV below and why it’s a dangerous metric, but effectively here you want to understand what your future LTVs (or future cash flows generated by each customer) will look like. You calculate it by saying how many months do you estimate that the customer will stay with you * gross profit per user per month. In essence: You assume a customer will stay for 24 months, you make $100 in gross profit per month = $2,400 LTV. You can modify the monthly LTV prediction in the top cell.
- ROI: The last metric we look at is ROI, which is calculated by dividing the LTV with the CAC, or LTV/CAC. Imagine your LTV is $3,000 and you spent $1,000 to acquire a customer. Your ROI is 3.
If you want to be more advanced you can even use a similar framework and divide each marketing spend by channel, That way, you can understand the ROI, payback, gross profit and so on segmented by each channel.
A Word of Caution: Don’t Solely Focus on Customer Lifetime Value
We have all been told to look at LTV and CACs to understand our marketing ROI—and that’s not wrong, per se, but those terms have possibly been overused a bit. To the extent that small businesses and first-time entrepreneurs might think “Hey, my first 5 customers just bought for $100 each this month. I think they’ll love me so much that they’ll purchase for $100 for the next 4 years. Aha, so I have an LTV of $100*4years (48 months) = $4,800. Wow!” This leads to overspending quickly.
Let us go through what’s wrong here (and why LTV is super dangerous for new businesses).
- Uncertainty. When business is totally new, so it has no data on how long a customer will stay with it. We can all sit on a Saturday evening and give a guess of 48 months, but it is often way too far in the future to make any good predictions. Imagine your company is a few months old and you’re making predictions about the next 48 months—that’s very tricky.
- Misunderstanding. Due to the wrong assumption on LTV, say that you “predicted” that people will stay with you for 48 months and your LTV will be $4,800. In that case, according to the famous ROI rule of 4:1, in theory you could spend $1,200 to acquire a customer. But that’s way too high for most and your cash flow will never sustain investments like these and you’ll burn all your cash before you start to generate any cash flows.
Instead, look at gross profit per user and payback period before LTV and you’ll drive profitable growth from day one.
What is gross profit?
Gross profit is simply put your revenue minus cost of sales. As an example, Alexander sells t-shirts and he charges $30.00 for a t-shirt. The t-shirt costs him $10.00 to manufacture, so his Gross Profit is $20.00.
What is payback period?
Payback period is a function of (investment divided by the return). For example, Alexander spent $1,000 on an online ad to promote his t-shirts. Because of the ad he will sell 10 t-shirts every month in the next 12 months. He makes $20.00 in gross profit per t-shirt * 10 sales per month = $200 in gross profit per month. Alexander has a payback period of five months (investment of $1,000 / $200 in gross profit per month). It will therefore take him five months to recover his $1,000 investment back. Not bad.
Here’s why tracking payback period over LTV is smarter for early stage companies:
It provides a tangible understanding of when they marketing spend will be recovered.
It helps you plan your cash flow better.
It is not such a “guesstimate” as LTV is—you can actually provide real-world numbers.
And those real numbers are just one of the reasons a marketing P&L is a must.
Key Takeaways for Your Marketing P&L
To summarize, here are the three key takeaways that you should remember:
- Ensure that your marketing department is 100% aligned with your overall business and P&L. Get your Marketing Team to run their own P&L (and not just a budget) and assign them full ownership.
- Make sure you track the right metrics. Not just big ones like revenue and gross profit, but track sub-metrics like payback period and ROI to fully grasp the return on marketing, and make sure that your marketing team is focused on driving quality cohorts of customers, and not just random customers.
- Remember that LTV can be dangerous for new businesses as you have very little data to make a real LTV prediction and we recommend that you supplement it by tracking payback period, as this is a vital metric for your cash flow and for your marketing planning.
A marketing P&L will help you to drive profitable growth (and not just random growth) to ensure you don’t run out of cash. With this guide, you have all the information you need to either assign your marketing team their own P&L or take charge of it yourself. And if you want to learn more about automating your P&L, join us!