By Vincent G. Dong, CPA, CA
Time. Time. Time. As I gaze out on the lake at the cottage, I look back on the time-consuming events over the last 9 months. Two weddings. Two funerals. Our first grandchild. Some of it gave me great personal joy and some of it left me with lingering sadness. The time that went into those events is a ton of time that I will never recoup.
As a result, the last year has certainly heightened my mindfulness and reflection skills regarding the agencies I work with and how they spend their time on their clients.
More than ever before, I have watched how agencies put more and more (not less!) time into their clients in every possible way because, it is in their culture to do so, they are afraid of losing or upsetting the client, they earn even more business from the client or over…time… they become the “ marketing expert” 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 and what IS your agency’s overall strategy in the deployment of your staff.
At the heart of this article, 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!
In order to analyze time incurred, you’ll need to have the necessary reporting tools to do so. I rely on Client P&L and BT reporting.
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?”.
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 profit. Not quite. Everyone gets AGI. Gross billing less reimbursed costs. Three additional expenses have to be factored into the equation to arrive at the final figure.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). Incidentally, there is a direct correlation to 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 a 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 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 in order to have accurate reporting.2. Non-billable third-party costs
From time to time, as we are only human, we make honest mistakes with respect to third party vendor costs. 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
It is important to ensure that the overhead costs of the agency, for example, rent and IT costs, be allocated to each client’s P&L. How so? There are three ways;
- By AGI percentage. In this case, the larger the AGI per client, the larger the overhead allocation, regardless of how much 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 the seniority of the staff members, the more the overhead is allocated. Is that anymore fair than the AGI percentage allocation?
- By labor cost. In this case, the total value of labor per client is captured for overhead allocation purposes. 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 as it represents the allocation of the agency’s overhead based on staff effort.
To recap, a client P&L is the result of the AGI less labor cost, non-billable third-party costs and overhead costs. If your software system is an all-in-one program, the total net income(loss) of the individual Client P&L’s should add up to the agency’s income(loss) at a given time.
When reviewing the individual client P&L’s in summary, they should be compared to the three industry-standard percentages, labor 50%, overheads 30% and profit 20% against AGI.
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 between clients, it’s time to take a deeper dive into why this is happening. One client at a time. 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!
What is the objective on 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?
It’s that last sentence that brings me to the reasoning to make a direct comparison to the Billable time report against money-losing, not profitable clients.
More and more clients tell me that they don’t bill for their time. They prepare an estimate and live and die by it. Thus, their reason not to enter time. 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, we do things a little differently here…”. As a result, I see many types of hourly billing rates. Blended, by service type, by employee and even what the client is prepared to pay per hour. In essence, many different external billing rates.
When I help agencies set or re-set their external billing rates, we start with the hourly cost of the employee (discussed above) and multiply by no less than three times. This multiple covers for 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.
Secondly, 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? There is value to comparing the AGI earned on a client project (on the client P&L) vs. what could have been billed (one the Billable time report).
We call this the opportunity cost of time. For example, if you provided an estimate to a client for $50,000 and the billable time report indicated $75,000, 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. It certainly is worthwhile to review clients that have significant lost revenue opportunities to determine if there is a pattern and mostly to course-correct the internal workings of a client.
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 that are internally accountable for not only maximizing the profit per client but also to maximize the AGI per client. Why not consider looking at your external billing rates to ensure they are current and even look at having a manageable number of rates.
So, in the end, 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 a more than sufficient profit, use your client P&L. For the loss clients and high labor percentage clients, naturally both reports should be used.
Vincent G. Dong, CPA, CA
A word on Vince. Vince is the founder of Ad-Vice Software and Consulting Inc. He advises independent marketing agencies in North America to help them make more money.
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