For Australian small and medium enterprises (SMEs), understanding the profitability threshold for paid advertising is absolutely critical. It’s not just about getting clicks; it’s about ensuring those clicks translate into genuine return on investment. Many businesses start running ads without a clear picture of what ‘good’ looks like, and that’s a recipe for wasted budget. We see it time and time again.

The simple answer? Your return on ad spend (ROAS) needs to exceed your profit margin. However, calculating that isn’t always straightforward. Here are a few key insights to help you determine your profitability threshold.

• Gross Margin is Your Baseline: Before even thinking about ads, know your gross margin. This is your revenue minus the direct cost of goods sold. If you sell a product for $100 that costs $60 to make, your gross margin is $40, or 40%. Your ROAS *must* be higher than this to be profitable.
• Account for All Costs: Don’t just consider the cost of the product. Factor in operational expenses – things like wages, rent, and software subscriptions. These reduce your *net* profit margin, meaning you need a higher ROAS to achieve overall profitability.
• Customer Lifetime Value (CLTV) Matters: If your ads attract customers who make repeat purchases, CLTV changes the equation. A lower initial ROAS might be acceptable if a customer is likely to spend significantly more with you over time. We often advise businesses to model different CLTV scenarios.
• Attribution is Key: Understand how your ads contribute to sales. Is it the first click, the last click, or a combination? Accurate attribution modelling helps you correctly assess ROAS and optimise your campaigns. Many platforms are improving their attribution capabilities, but it’s still an area where careful analysis is needed.

Let’s say your net profit margin is 25%. This means for every $100 of revenue, you keep $25. To be profitable, your paid advertising needs to generate at least $100 in revenue for every $25 spent – a ROAS of 4:1. If you’re selling higher-value items or anticipate repeat business, you might be able to operate with a slightly lower ROAS, but always start with your profit margin as the minimum benchmark.

The best next step is to conduct a thorough profitability analysis of your existing products or services, then calculate your net profit margin. Once you have that number, you can set realistic ROAS goals for your paid advertising campaigns and start tracking your results. Don’t just run ads – run *profitable* ads.