I visited an agency earlier this year and was intrigued by a comment the owner had made.
“We don’t bother with client P&Ls. My company earns a decent profit.”
In reality, the company was not in a position to produce client P&Ls because they didn’t have an integrated software program, but that’s not the focus of this article. The agency didn’t really know what each client was contributing to the company’s profit.
Procurement was established not to be a pain to ad agencies, but to ensure that a company’s outlay on a product or service brings about the maximum return on investment (ROI) for the least amount of money.
Why shouldn’t ad agencies look inward at this concept the same way—by reviewing the ROI of its staff AND how to manage its client relationships through analysis of client P&Ls? Not enough agencies spend enough time examining their own business; they’re too preoccupied with client matters, or they don’t have the software systems in place for that particular determination.
What’s in a Client P&L?
Let’s start with the definition of a client P&L.
A Client Profit and Loss report starts with the client’s adjusted gross income (AGI) less TWO costs:
- The cost of direct labor posted against the client’s AGI, and
- The cost of overhead allocated against the client’s AGI.
Therefore,a Client P&L = AGI less Direct Labor + Overhead.
This definition then requires TWOfurther definitions.
Cost of labor.This is the time posted to a client/project multiplied by the hourly cost of the employee. (I’ll write more on employee hourly cost in a future article.)
Cost of overhead.In order for a client P&L to be accurate and complete, overhead from the company’s income statement needs to be fairly allocated to clients.
The cost of overhead per client can be based on as many as three separate allocations:
The percentage of client AGI relative to the agency’s AGI.For example, if the client’s AGI represented 15% of total AGI, 15% of the overheads would be allocated to the client P&L. If a specific client’s AGI contribution was 35% of a company’s AGI and required very little labor, would it be fair to allocate that much overhead to the client?
The percentage of hours on that client relative to the total client hours posted.For example, if the client hours posted represented 22% of total client hours posted, 22% of the overheads would be allocated to the client P&L. What if the agency principal didn’t do time sheets, and spent a great deal of time on certain clients; or, what if certain highly-paid employees (at higher hourly rates) worked on client accounts? Would the percentage allocation of staff hours be fair to client P&Ls in these cases?
The percentage of labor costs on that client relative to the total labor costs posted to clients.For example, if the labor costs on a client represented 37% of the company’s labor costs posted to clients, 37% of the overheads would be allocated to the client P&L. This option would certainly be representative of the value of labor required to service each client!
As a cross check, the sum of the individual Client P&Ls should agree to the agency’s income statement.
Why Do a Monthly Client P&L Review?
When we examine the profit or loss by client, it is interesting to see how an agency utilizes its resources.
If we apply the advertising/marketing industry standard of 50% labor, 30% overhead and 20% profit against AGI to compare your clients, there will be, not surprisingly, a mixture of clients who earn a respectable profit percentage for the agency, and also clients that lose money for the agency.
I visited an agency for this very issue last year. It turned out that half of the agency’s clients were earning a profit… andhalf of the clients were losing money for the agency. Needless to say, the company’s profit was less than the 20% industry norm.
Now that we have this formula at our fingertips, what are the top 10 reasons for the monthly review of a client P&L?
- Ensures that your company income statement is accurate.
- Not only do you learn the dollars in profit/loss your individual clients are contributing, you get to see the percentage each client contributes to your bottom line.
- Determines the profitability of your top ten billing clients.
- You get to review the efforts of your staff on clients that most often drive 80%+ of your AGI. You can then allocate people accordingly to ensure the best staff ROI.
- Provides greater financial metrics.In cases where a client is earning you considerably less than 20%, you gain the metrics to;
- Ask your client for more money;
- Reassign your staff to more profitable work;
- Determine how much longer you want to lose money on that account;
- Be conscious of the time investment on this account for;
- Possible future referrals from underperforming clients,
- Staff education where ROI is low because of the client, or
- Obtaining new educational inroads to different industries.
- Creates another layer of reporting.If account managers are assigned to multiple clients, you will have the necessary reports to compare profitability of account managers (AMs), assess profitability by AM, and even use the data as a tool for a staff bonus plan. If the company wins, so should the staff members!
- Identifies the risks of your “gorilla” client by determining AGI and profit contribution to the agency.
- How many staff would have to be trimmed if you lost the client?
- Acquire helpful information to plan for staff increases if the gorilla gave you even more business.
- Identify a great training ground for inexperienced staff if the profit percentage was exceptionally high; and
- State internally what more or less you might do for the client.
- Determines the degree of staff efficiency or inefficiency.
- You will have a clear picture of employee productivity and recoverability for a client if you assign, for example, high hourly rate employees to certain clients. (I’ll cover employee productivity and recoverability in future article.)
- You gain helpful insights into why a client is not profitable. Is it a not-for-profit? Is it a great referral client? Is it a client in a different vertical? Is it that you’re not interested in making money?
- Determines trends within client accounts.
- If month-to-month profit swings are substantial, is it a staffing issue? Is it a timing issue? Is it a change in the type of work? Is it a client issue?
- Creates valuable information for investing time into clients for future work.
- If you’re earning 30% profit on a client, why not consider putting more time on the client in order to ensure more long-term profit?
- Conversely, if you pay your staff well and a client is not prepared to pay your fees, it would be extremely beneficial to present proper business metrics to the client for fee augmentation discussions.
- Establishes a road map for future profitability by setting parameters.
- What would an employee think if they saw the agency only earning 5% profit on a client when the agency norm is 20%?
- Focuses on the kind of work you earn the most profit from.This analysis would validate, say, a particular niche or industry in which you work.
AMS and P&Ls
From a financial discipline standpoint, if you have a monthly check-in with your clients, you owe it to yourself to do the same for your own agency.
If you have a front- to back-end agency management system (AMS), you should have client P&L data at your fingertips. Your accountant would then have the time to analyze and interpret the data before discussing it with you.
If you don’t have a comprehensive AMS, your accountant would need to take valuable time to prepare the same data. That means the accountant would have less time to do the agency’s other analytical work. For agency leaders of growing agencies to have adequate qualitative analysis for decision-making, a good AMS is essential.
In the meantime, let’s all have fun making money while knowing more about our business!
Vince Dong, CPA, CA, consults with independent marketing agencies in North America to help them make more money.
© 2018 Vincent G. Dong. All Rights Reserved.