AdWords campaigns can be a great way to reach out to targeted and highly-motivated buyers. They can also be a huge drain on marketing budgets. Here’s the five-step mathematical process to determine the return of your AdWords campaign, and what to do to improve the returns if performance isn’t what you expect.

Step 1: Determine your Average Order Value (AOV)

This number will be different for different types of online retailers, and there are a couple of ways to calculate it. Generally speaking, you want to take at minimum a three-month or six-month average of the amount spent per person.  If your business is seasonal, you may want an entire year’s worth of data in order to get a number that reflects purchase numbers over time.

Step 2: Determine the Average Lifetime Value

This number will also be different depending upon the type of online retailer. For subscription-based online merchants, the average lifetime value will be the cost of the subscription times the average number of months a user is subscribed. For other retail stores, it will be the average order value, times the average number of repeat orders per user.

Step 3: Determine Your Conversion Rate(s)

The conversion rate on PPC ads is the number of website visitors who make a purchase after clicking on an ad, divided by the total number of website visitors who click on the ad, expressed as a percentage. So if you have 10 sales for every 100 clicks on a particular ad, your conversion rate is 10% for that ad.

It is expected that different ads and ad groups will have different conversion rates. If there is a significant difference in performance between ads or ad groups, you may want to calculate the cost of acquisition in the next step separately for each ad or ad group based on performance.

Step 4: Determine the Cost per Acquisition

The cost per acquisition is calculated by taking the cost per click (CPC), multiplying it by the number of clicks to get total spend, then dividing that number by the number of conversions.  So if the CPC is $0.20 and there were 100 clicks with 10 conversions, your cost of acquisition would be $2.00 ($0.20 x 100 clicks = $20.00. $20.00/10 conversions = $2 per conversion).

Step 5: Bring it All Together

In order to determine if your returns are positive or negative, you simply subtract the cost per acquisition from the average order value. So if the average order value is $20 and your cost per acquisition is $2, you have a positive return of $18. If you have an overall positive return, increasing the amount you invest in your PPC campaign can yield higher click numbers, and in turn more conversions and greater profit.

However, if you return is negative, there are a few things you can do to evaluate performance:

1. Check individual ad performance – perhaps some of your ads are giving positive returns. You should focus on increasing the budget for these ads, while eliminating poor performing ads.
2. Check your keywords – often, low conversion rates can be tied to poor keyword performance. You may need to add negative keywords to eliminate people who aren’t ready to purchase, or you may need to find less-expensive keywords that will still perform well for you.
3. Check your conversion funnel – if there are particular areas in the conversion funnel where drop-offs are steep, conversion optimization and A/B testing can help you to solve the problem and improve your overall conversion rates and revenue.

Sound off: What’s your biggest challenge with your PPC campaigns?