Cost of Acquisition: What it Means, How to Use in Investing

What Is the Cost of Acquisition?

The cost of acquisition is the total expense incurred by a business in acquiring a new client or purchasing an asset. An accountant will list a company's cost of acquisition as the total after any discounts are added and any closing or transaction costs are deducted.

Cost of acquisition, which is also referred to as acquisition cost, is used for accounting purposes and in business sales.

Understanding the Cost of Acquisition

As an accounting term, the cost of acquisition includes all upfront costs incurred when purchasing a business asset such as equipment or inventory. It includes the following:

• Purchase price of the item
• Costs to ship it to its point of use
• Costs to install the item
• Costs to get it up and running (in the case of equipment) or ready for sale (in the case of inventory) condition

The business normally adds in other expenses like closing costs, customs and fees, and other miscellaneous expenses when calculating the cost of acquisition. Any discounts are also reflected in this line item.

As a business sales term, the cost of acquisition includes expenses related to marketing such as promotional materials, travel by salespeople, and sales commissions. The cost is tied to marketing and sales because the more streamlined those campaigns become, the lower the cost of acquisition will be for each customer.

Why Cost of Acquisition Is Important

Here’s why knowing the cost of acquisition matters when dealing with a capital asset:

• Informed Investment Decisions: Understanding the cost of acquisition helps businesses make informed decisions about purchasing capital assets. By accurately calculating the total cost, including purchase price, transportation, installation, and any other related expenses, companies can evaluate whether the investment aligns with their financial goals.
• Depreciation and Tax Benefits: The cost of acquisition directly impacts the depreciation schedule of a capital asset. A higher acquisition cost may lead to greater annual depreciation expenses, which can reduce taxable income and provide tax benefits.
• Asset Valuation and Resale Value: The cost of acquisition plays a role in the asset’s valuation and future resale potential. If the company plans to sell the asset at a later date, knowing the original cost helps in setting a competitive resale price that reflects the asset’s remaining value.
• Risk Management: Understanding the cost of acquisition helps in assessing the risks associated with acquiring a capital asset. By evaluating the total investment required, businesses can weigh the risks of potential underperformance, obsolescence, or unforeseen maintenance costs. This can also help with planning for future similar acquisitions.
• Impact on Financial Statements: The cost of acquisition affects a company’s financial statements. Capital assets are recorded as long-term assets, and their acquisition cost influences the company’s total asset value, equity, and liabilities.

Reducing Acquisition Costs

One strategy to reduce acquisition costs is to conduct thorough market research and competitive bidding before making a purchase. By gathering quotes from multiple suppliers and negotiating terms, you can secure the best possible price for the asset. Also, consider timing the purchase to take advantage of seasonal discounts, promotions, or bulk purchasing deals can further reduce costs. For instance, you may be able to buy certain fixed assets from liquidation sales.

Another approach to lowering acquisition costs is to consider alternative financing options. Instead of purchasing a capital asset outright, you might explore leasing or financing arrangements that spread out the cost over time, reducing the immediate financial burden. Keep in mind you may end up paying more in the long run due to interest, but the actual cash outlay may not be as high in the beginning.

Finally, evaluate the total cost of ownership rather than just the initial acquisition cost. This means considering all expenses associated with the asset over its lifetime, including installation, maintenance, operation, and disposal costs. In some cases like buying a longer-term warranty upfront, you may pay more in acquisition costs but less over time otherwise.

How Investors Use Cost of Acquisition

Investors who read financial statements may take a great interest in a company's cost of acquisition, particularly if that number is unusually high or low.

For example, cable companies, telecommunications companies, and subscription streaming services generally have high costs of acquisition. They have to spend a lot of money on marketing and promotions in order to acquire new customers. This is especially true in competitive markets where consumers have a choice.

Contract buyouts from competing cable companies and offers of family plans for wireless customers are among the promotions that companies in this industry use to attract new customers. These are expensive examples of costs of acquisition.

Cost of Acquisition in Marketing

The cost of acquisition is also a marketing term. It refers to the total expense a company incurs to acquire a new customer and includes all the costs associated with persuading a potential customer to purchase a product or service.

These costs encompass a wide range of marketing and sales expenses, such as advertising spend, salaries of marketing and sales teams, costs of promotional campaigns, and other related expenses. Understanding the acquisition cost of a customer is central to businesses as it directly impacts profitability and the efficiency of marketing strategies.

One of the primary reasons why businesses track the cost of acquisition is to measure the effectiveness of their marketing efforts. Companies can determine how much they are spending to bring in each new customer, allowing them to assess the return on marketing campaigns. If the cost of acquisition is too high relative to the revenue generated by a new customer, it may indicate that the marketing strategy needs adjustment. For instance, the company might need to optimize its ad spend, refine targeting, or enhance its sales processes to lower costs and improve efficiency. Alternatively, it may be more effective to sell more products to existing customers instead of trying to "lure" new customers.

Key Metrics for Cost of (Customer) Acquisition

There are several metrics marketing professionals use to track the effectiveness of marketing campaigns and new customers. Several ways to track the cost of acquiring a new customer include but aren't limited to:

• Customer Acquisition Cost (CAC): CAC is the most direct metric for tracking the cost of acquiring a new customer. It’s calculated by dividing the total marketing and sales expenses by the number of new customers acquired during a specific period. This metric provides a clear picture of how much it costs your company to bring in a new customer.
• Cost Per Lead (CPL): CPL measures the cost of generating a sales lead, which is a potential customer who has shown interest in your product or service. This metric is important because not every lead converts into a customer. By tracking CPL, businesses can evaluate the efficiency of their lead generation efforts and identify which channels or campaigns deliver the most cost-effective leads.
• Conversion Rate: The conversion rate measures the percentage of leads that convert into paying customers. This metric directly impacts the cost of acquisition, as a higher conversion rate typically lowers CAC.

The Bottom Line

In accounting, the cost of acquisition reflects all the costs related to buying an asset, such as equipment or a competitor. In the context of sales and marketing, cost of acquisition is used to determine all of the costs related to acquiring new customers. In either scenario, knowing the cost of acquisition helps companies plan for the future and allocate money.