Time. Time. Time. As I gaze out the window in my office, I look back on the time-consuming events over the last 12 months. Our fourth and fifth grandchildren were born, two bike accidents in Asia, a wedding in the south of France and completing 30 years in my office. Some of it gave me great personal joy and some of it left me with the feeling that it sucks getting old. The time that went into those events is a ton of time that I will never recoup.
As a result, the last year certainly heightened my mindfulness and reflection regarding the agencies I work with and how they spend their time on their clients. More than ever before, I have watched how agencies have put more and more (not less!) time into their clients in every possible way because it is in their culture to do so.
They do so because;
- They may be afraid of losing or upsetting the client
- They could earn even more business from the client
- They could become the “marketing arm” of a niche-based client
This article is about
- Reflecting on the time you’ve put into your clients
- The money you’re earning (or not) from them
- What else could you be doing with the people in the company?
- What is your agency’s overall strategy in the deployment of your staff?
At the heart of this article is that I am firm on agencies entering time. Period.
Management Consulting Companies, Law, Architecture, Accounting and IT firms all do it. Why? That is how they earn money. I consider marketing and advertising agencies to be in the same professional status as the ones previously mentioned. No time entry. No accountability to… yourselves, not the client! To analyze the time incurred, you’ll need to have the necessary reporting tools to do so. I rely on Client P&L and Billable time reporting for the framework of time analysis for my clients.
What is the rationale behind this analysis? Easy.
Did we receive a sufficient and appropriate amount of compensation for the resources we deployed on our client?
Client P&L - The Calculation
Why is the client P&L so important to an agency? Let’s first define it.
Many agencies believe that the gross profit, also known as Adjusted Gross Income (AGI) IS the client profit earned from the client. Some even believe the cash they collect from the client is the client's profit. Not quite. Everyone gets AGI. Gross billing less reimbursed costs. However, three additional expenses have to be factored into the equation to arrive at the final figure of what is formally called, a client profit and loss.
1. Labor Costs
There is an industry standard for the determination of an employee’s hourly cost. It is the salary cost plus all benefits divided by a standard number of annual hours (This standard ranges between 1,500 and 1,600 hours). Salary * 1.2/ 1,500 hours.
Incidentally, there is a direct correlation between the external billing rate and an employee’s hourly cost but more on that later.
When an employee enters time on a client/project, they are adding their labor cost against the client’s AGI. If the employee chooses to enter that block of time elsewhere despite working on that particular client, they may overstate the profit of their specific client’s P&L by understating their labor cost and can unfairly place their labor cost on another client or simply bury it in a non-client time category like new business or education. It is important to be precise with one’s time entry to have accurate reporting on a client P&L.
2. Nonbillable third-party costs
From time to time, as we are only human, we make honest mistakes with respect to third-party vendor costs on client work. When the decision to not bill these costs happens, it is most correct to link these costs to the client that the outlay related for Client P&L purposes. Ideally, an agency should keep these costs to a bare minimum annually.
3. Overhead Allocation
Many agencies do not consider the fact that there are overheads that need to be apportioned against client AGI. This is the third “expense” required to determine a client’s profit or loss over a given period of time. It is important to ensure that the overhead costs of the agency, for example, rent, IT costs, and non-client salary costs, be allocated to each client’s P&L in order to see the net profit per client.
How would one allocate overhead? There are three ways:
By AGI percentage. In this case, the larger the AGI per client, the larger the allocation of overhead, regardless of how much or how little effort was exerted in servicing the client. How fair is that?
By labor hours percentage. In this case, the more hours entered on a client regardless of how senior or junior the staff member was, the more the overhead is allocated. Is that any more fair than the AGI percentage allocation?
By labor cost. In this case, overhead is allocated based on the labor cost per client. It includes the time of everyone entering time on the client whether they are junior or senior…so long as they enter their time. This is the fairest way to allocate overhead to clients as it represents the allocation of the agency’s overhead based on staff labor costs.
To recap, to calculate a client P&L, it is AGI less labor cost, non-billable third-party costs and overhead allocation. If your software system is an all-in-one program, the total net income(loss) of the individual Client P&Ls will add up to the agency’s income(loss) at a given point in time. This way, you can see which clients contributed positively and negatively to your company’s profit or loss for the period in question.
Client P&L Analysis
So now that we have spent all this “time” telling you how to arrive at a client P&L, here is what should be of analytical interest to the agency. When reviewing the individual client P&Ls in summary, they should be compared to the three industry-standard percentages, labor 50%, overheads 30% and profit 20% against AGI. If your clients are not earning 20% in profit for you, it is important for the well-being of the agency to find out why.
What you will uncover is some interesting information to digest.
You’ll find very profitable clients where the labor is in line. You’ll discover a number of clients where the labor percentage is much more than 50% against AGI and those clients are losing money. If you also find profit swings (month over month) between clients, it’s time to take a deeper dive into why this is happening. It would also be an interesting exercise to add up the totals on the profitable vs. losing clients to arrive at the total net profit! You could also uncover that the agency overhead totals exceed total labor costs!
What is the objective of this Client P&L analysis? To determine what your ROI is with each and every one of your clients and to reflect and ask yourself some questions;
- Are you ok with that return?
- Are you ok with offering so many different levels of service and your return is minimal?
- What more can you do with a client earning you 30%?
- Are you perfectly content with losing money on a particular client for the last three years?
At the heart of it is for the agency to understand the internal financial metrics of its clients and not just worry about getting the client invoice out and billing the client for services rendered.
As a result, a direct comparison of the Client P&L to the Billable time report needs to be reviewed as well. What could we have billed to the client vs. what did we actually bill to the client?
Billable Time – The Calculation
More and more clients tell me that they don’t enter time. They prepare an estimate and live and die by it. That is their reason not to enter time. Makes no sense to me or…they don’t know (or care for that matter) what they don’t know from an agency financial metrics standpoint. Yet, there is the other side of the coin to consider. For all that an agency does today, it is about being internally accountable for their time.
What do I mean? Let’s first define billable time.
At the heart of this is the value of each hour. Whenever I visit an agency, they usually start with, “Vince, around here, we do things a little differently here…”. As a result, I see many types of hourly billing rates. Blended, by service type, by employee, what the market will bear, what the client is prepared to pay per hour, and even made-up rates. In some cases, I have seen some agencies that have not increased their rates in 5 years yet oddly enough, they give annual salary increases to staff. In essence, many different external billing rates exist in the industry.
What defines an external billing rate? A rate that should be high enough to cover labor, overheads and profit unless you are desirous of being a charitable organization, which I wonder about some agencies. When I help agencies set or re-set their external billing rates, we start with the hourly cost of the employee (covered in the labor cost section of the client P&L calculation) and multiply by no less than three times. This multiple covers the cost of the employee, overhead and profit. Depending on what services you offer, the multiple may be upwards of 4 and 5 times as well. However, if you set your external billing rates too low, you run the risk of not earning a company-wide 20% profit.
Billable Time Analysis
There are two reasons to enter one’s time into a client project;
- For labor costing purposes and,
- To see what the billable time is on a client project.
Why? For management reporting purposes, it is important to compare the difference between AGI billed and earned on a client project vs. what could have been billed especially if there is a material difference between the two figures. For example, if you provided an estimate to a client for $50,000 and the billable time was $75,000 on the job and you could only bill the $50,000, one could interpret this $25,000 in what-could-have-been-earned additional revenue as the opportunity lost to earn revenue against another client project OR consider it as a write-off.
It should be part of the month-end management reporting review to see how much of this revenue was not earned or simply put, written off by write-off category by:
- job,
- job type,
- client and
- employee
It is important to do so to determine if there is a pattern for these overages and mostly to course-correct the internal workings of a client and even improve the estimation of certain types of jobs.
Years ago, I visited an agency and the owner proudly showed me a 10%, $600,000 operating profit on his income statement. He was so proud of that figure. I then asked to see the write-offs report and he had no clue about such a report. I turned to the controller and asked the same of him and moments later he brought it back to me. The write-offs for the year in question oddly enough came in at $600,000. It was the first time the owner saw such a report. After I resuscitated him, I asked him to pay equal attention to the revenue dollars that were being written off moving forward as his income statement. Today, this agency is north of 25% in operating profit.
It is at this juncture that I cannot emphasize enough the importance of accurate time entry for both costing and revenue-earning purposes. With all that being said, it is important to ensure that a consistent external billing rate is understood by everyone in the agency especially those who are internally accountable for not only maximizing the profit per client but also maximizing the AGI per client. When was the last time you adjusted your external billing rates?
So, what is more important to review? Client P&L or Billable Time Reports? I’m a big proponent of managing by exception. For those clients that are doing just fine and humming along with more than a sufficient profit, use your client P&L. For the loss clients and high labor percentage clients, naturally both reports should be used. Happy analyzing!
