Maximize your profits by applying IRR in your agency

Investing in marketing and not seeing clear results is frustrating. The Internal Rate of Return (IRR) is the key to changing that. Understanding and applying the IRR is crucial for determining which marketing strategies are truly valuable for your agency or WordPress project. This article will show you how the IRR can turn your investment decisions from mere guesses to calculated and profitable strategies.

What is the internal rate of return and why is it important for your agency?

The Internal Rate of Return (IRR) is like a rule that measures whether the money you invest in your marketing business will yield good results. It’s similar to when you plant a tree and want to know if it will give you enough fruit to justify the cost of planting and caring for it.
How is the IRR calculated? The formula to calculate the IRR is a bit complex, but think of it as a way of adding up all the money you expect to earn in the future, adjusting it to what it’s worth today. The formula looks like this:

NPV=∑(1+TIR)nFlujosdeCaja​=0

Here, the important thing is to understand that we are adding up the money you will earn (Cash Flows), but adjusting it to its current value.

Simple step-by-step example:

1. Initial investment: Imagine you spend €10,000 on advertising for your business.
2. Money you expect to earn: Suppose you expect this advertising to help you earn €3,000 in the first year, €4,000 in the second, and €5,000 in the third.
3. Calculating the present value of future money: We use the formula to understand how much those €3,000, €4,000, and €5,000 you will earn in the future are worth, but considering their value as if you had it today.
4. Decision based on the IRR: The IRR helps us see if the money we expect to earn in the future, adjusted to its current value, is more than the €10,000 we initially spent. If the IRR is high, it means that the investment is good; if it is low, maybe not so much.

Calculate the IRR of your Investment Project with Ease

With this online tool, you can determine the profitability of your marketing projects easily and accurately. It is not necessary to be an expert in financial mathematics, just follow the link and start calculating your IRR!
Access the IRR Calculation Tool

This tool will help you make more informed decisions about your marketing investments and evaluate the profitability of your projects quickly and efficiently. Don’t wait any longer and start using it now!

How to estimate cash flows to calculate the IRR easily

To calculate the Internal Rate of Return (IRR) of your marketing project, you need to predict how much money will come in and go out of your business in the future. Here I explain how to do it in a simple way:

1. Choose the Time Period: First, decide how long you will calculate this money movement. It can be every month, every three months, or every year. Normally, you look several years ahead.
2. Estimate Future Income:
   • Look at your Past Campaigns: Think about how you have done in similar campaigns you have done before.
   • Research the Market: Observe what is happening in the marketing world and how it could change what your customers want or need.
   • Think about your Goals: If your goal is to make more people aware of your brand or sell a new product, estimate how much money you think this will bring you.
3. Calculate what You Will Spend:
   • Direct Expenses: This includes things like the ads you pay for and the money you give to other companies for their help.
   • Indirect Expenses: These are things like what you pay your employees, the rent for your office, and other general expenses.
4. Consider External Changes: Think about things like changes in the economy or what your competitors are doing, which could affect how much money you earn or spend.
5. Do a ‘What If’ Analysis: Imagine different situations, like the best that could happen, the worst, or the most likely, and how they would affect your money.
6. Use Tools to Help You: You can use special computer programs to put all these numbers together and see how they add up.
7. Review and Adjust Your Numbers: It’s important to look back at your calculations from time to time and change them if things aren’t going as you thought or if something important in the market changes.

By doing all these steps, you will have a good idea of how much money you expect to come in and go out of your business in the future, which is essential for calculating the IRR of your investment in marketing.

Why it’s important to calculate the IRR even if you know you will earn more money in the future

The IRR is a way to measure how good an investment is, considering both the amount expected to be earned and the time it will take to earn it.

1. Value of money over time: The IRR takes into account that money has a different value over time. For example, €1,000 today does not have the same value as €1,000 in a year due to factors such as inflation and the opportunity to invest that money elsewhere. So, even though your future earnings add up to more than your initial investment, the IRR helps you understand how much those earnings are worth in current terms.
2. Required rate of return: The IRR allows you to compare the profitability of your investment with a rate of return that you consider acceptable or with other investment opportunities. For example, if your required rate of return for any investment is 10% per year, the IRR tells you if your marketing project meets this criterion.
3. Risk and profitability: In addition to numerical gains, the IRR helps you evaluate the balance between risk and profitability. Even if you know you are going to make profits, the IRR informs you if the profitability of your investment adequately compensates for the risk you are taking.
4. Strategic decisions: It’s common to have multiple options for investing. The IRR offers a standard measure for comparing different types of projects or campaigns, even if they have different time scales and investment amounts.

Detailed example: IRR calculation for a marketing campaign at “Creative Designs S.A.”

Context: “Creative Designs S.A.” is a marketing agency specializing in graphic design services and digital advertising campaigns for small and medium-sized businesses. The company plans to launch a new campaign called “Digital Boost” to promote its web design services.

Step 1: Definition of the Time Period

They decide to calculate cash flows for the next three years, as they expect the effects of the campaign to materialize in this period.

Step 2: Estimation of Future Revenues

• Analysis of Previous Campaigns: They review their similar previous campaigns and note that, on average, they generated a 20% increase in sales the first year, followed by a 15% increase in the subsequent years.
• Market Research: The current trend shows a growing interest in personalized web design services.
• Campaign Goals: “Digital Boost” aims to increase clientele by 25% in the first year, and 20% annually thereafter.

Step 3: Calculation of Associated Costs

• Direct Costs: The campaign will cost €12,000 in digital advertising and €3,000 in software and tools.
• Indirect Costs: An estimated €5,000 annually in additional salaries and overhead expenses.

Step 4: Consideration of External Factors

They anticipate that competition could intensify, but they are confident in the quality of their offering.

Step 5: Sensitivity Analysis

They make projections for optimistic, pessimistic, and realistic scenarios.

Step 6: Use of Projection Tools

They use financial software to model their cash flows.

Step 7: Review and Adjustment

They commit to reviewing their estimates quarterly.

IRR Calculation

1. Initial Investment: The total investment in “Digital Boost” is €20,000 (€12,000 in advertising + €3,000 in software + €5,000 in indirect costs).
2. Estimated Cash Flows:
   • Year 1: They estimate an increase in revenue of €25,000.
   • Year 2: An increase of €20,000 in revenue.
   • Year 3: Another increase of €20,000 in revenue.
3. Application of the IRR Formula:
   • The cash flows are: -€20,000 (initial investment), +€25,000, +€20,000, +€20,000 for each of the three years.
   • We calculate the IRR using these cash flows.

Solving this equation for IRR, we would find that the IRR is approximately 100%.

The calculation of the Internal Rate of Return (IRR) for the “Digital Boost” campaign by “Creative Designs S.A.” results in an approximate IRR of 100%. This means that the investment of €20,000 in the campaign will not only be recovered, but is expected to generate a return equal to the amount invested in terms of present value.

Conclusions

The Internal Rate of Return (IRR) is an essential tool for any marketing business, including your agency or project in WordPress. Through this article, we have explored in detail what the IRR is, how it is calculated, and why it is fundamental.
We have learned that the IRR evaluates the profitability of an investment considering both the expected amount of earnings and the time it will take to obtain them. Additionally, we have seen that the IRR takes into account the value of money over time, the required rate of return, and the balance between risk and profitability.

We have also explored how to estimate cash flows, a key step in calculating the IRR, and how to implement this metric in strategic decision-making in your marketing agency.

Finally, we have presented a detailed example that guides you through a complete IRR calculation for a fictitious marketing campaign. We hope this example has provided you with a practical understanding of how to apply the IRR in your own marketing business.

Ultimately, the IRR gives you the ability to make informed and strategic decisions about your marketing investments, allowing you to identify the most valuable and profitable opportunities for your agency or WordPress project. So, go ahead! Use the IRR as your financial compass and elevate your marketing strategies to a more calculated and successful level.

Frequently Asked Questions

1. What is the IRR threshold considered “good” in marketing?

• Answer: The IRR threshold considered “good” in marketing can vary depending on the industry and the project’s risk. Generally, an IRR that exceeds the cost of capital rate or the required rate of return is considered good. For example, if your cost of capital rate is 10%, an IRR of 15% would indicate that the project is profitable and exceeds the required rate. However, it’s important to remember that what is considered “good” can be subjective and depends on your specific objectives and standards.

2. How do taxes and inflation affect the calculation of the IRR?

• Answer: Taxes and inflation can affect the calculation of the IRR by influencing future cash flows. It’s important to adjust cash flows to account for taxes on earnings and the loss of purchasing power due to inflation. To do this, it’s necessary to consider the applicable taxes on profits and discount future cash flows in real terms (adjusted for inflation). This ensures that the IRR calculation accurately reflects the present value of cash flows in a fiscal and inflationary environment.

3. Can I use the IRR for short-term marketing projects?

• Answer: Yes, the IRR can be used for short-term marketing projects, such as temporary campaigns. However, it’s important to adjust the time period in the IRR calculation to match the duration of the project. In the article example, a three-year period was used, but for short-term projects, the period could be months or even weeks. The IRR remains a useful tool for assessing the profitability of these short-term projects and determining if they generate a sufficient return within the established time.