When agency owners first get in touch to discuss their finances, it’s usually one of two situations:

Client A - We are pleased with the growth of the agency so far, the team works well together and the business is making a reasonable amount of profit. However, we know in the agency world that things can turn quickly and would like to feel more in control of the finances.‍

‍We want to have more processes in place to review costs & profit margins, a more strategic method for setting sales targets and a pricing structure that is more “put together” than “make do”.‍

‍Client B - We had a good few years of growth, but it feels like we have been winging it for a while now and things are beginning to head in the wrong direction. One might say, a slight panic is setting in!‍

‍We have been meaning to sort out our financial processes, but there have never been enough hours in the day. These internal advancements always seem to get pushed back behind the million & one other jobs that have to be done.

Oh, I suppose there is a third reason:

‍Client C - Help, it’s all gone wrong! Our accounts are due next week and we really need someone to wave a magic wand and fix everything yesterday!

Thankfully, although this third reason still happens occasionally, it is much rarer now. I like to think this is due to the increasing number of agency owner communities that provide help & support to each other from day one, but who knows!

Regardless of which of those stages are relevant, the main reason for contact is a realisation that there needs to be greater control around both the finances and the commercial processes in the business. When an agency is new and still fairly small, the costs tend to be low. This means the agency remains profitable without the owner having to think too much about the specifics of finance - win work, do work, go home with a decent amount of profit - it’s that simple!

When the agency grows, the costs inevitably increase and there is a lot less profit to go round. As this starts to happen, suddenly all of those articles you read when you first set everything up begin to come to the fore. You know the ones with snappy titles like “Make Sure your Agency Charges Enough, Or You Will Suffer” and “Keep Track of the Profit Margins, Or Else”.

The big problem is that most agency owners are already stretched thin. You are probably doing the work of several people, attempting to keep your home life running & desperately trying to meet the targets you set for yourself so you don’t feel like a failure (even though just by setting up you have done more than most). So, although you know that you should be tracking profitability or reviewing profit margins, you’re not really sure how and you don’t know when you’ll ever have enough time in the diary to actually find out.

This is where we come in. This post is here to help with the lack of time and know-how and provide some basic methods of financial tracking to help get you started.

A pet hate of many, but such a useful tool for every agency. 

Remember, whether you charge a day rate, agree a fixed price per project or aim for value pricing, you are still essentially selling people’s time. Your team has a finite amount of hours in which to produce the work you sell. As an agency owner, you need to ensure that each of those hours can generate a sufficient amount of revenue to support your business.

For this reason alone, keeping track of the main thing you are selling should be seen as important. You would definitely expect a product business to accurately track their inventory, even if they don’t set consumer prices based on material costs; so why wouldn’t a service business track their time, regardless of pricing structure?

Agency owners that encourage their team to track time have access to a data set that allows them to review a whole host of metrics and the sooner you start the quicker you will be able to join them.

If you are looking for something quick to set up & easy to use, Clockify is free and a good place to start.

Next up is a good look at the costs of running your business. The majority of agency owners can tell you what their revenue was for the last few months, but a lot less will be able to tell you the equivalent cost base figures!

This is an issue because revenue is only half of the finance picture. Reaching £1m turnover is fantastic, but if your cost base is £1.5m then you’re still going to struggle to pay the bills this month.

Remember, costs are important.

The sections below are split between 3 sub-headings so that you also get a good idea of how much money you are spending on each of the different types of costs - Direct Staff Costs, Indirect Staff Costs & Overheads.

What:
The costs associated with paying staff to do client work
This can include employees, freelancers or subcontractors
For employees, make sure to include the full cost including Employers NI & Employers pension contributions

Where:
Employee cost information can be found in your payroll software
You can also look at individual payslips or payroll journals
Freelance & subcontractor costs should be recorded in your accounting software; to make things easier, set up separate codes for costs relating to “Cost of Sales / Direct Costs” and “Admin / Indirect Costs”

Why:
We want to know how much your agency is spending on directly servicing clients each month and across the year

What:
The costs associated with paying staff who work mainly on internal tasks
This can include roles such as finance, marketing, HR, general administration or sales
These can be full or part time roles and often include the salaries of the director
‍
Where:
Employee cost information can be found in your payroll software
You can also look at individual payslips or payroll journals
Freelance & subcontractor costs should be recorded in your accounting software; to make things easier, set up separate codes for costs relating to “Cost of Sales / Direct Costs” and “Admin / Indirect Costs”

Why:
We want to know how much your agency is spending on internal / non-client work each month and across the year

What:
These are the admin costs to the business
They include everything non-staff related, such as software subscriptions, office rent, advertising spend and web hosting
‍
Where:
Overhead costs can be found in your accounting software
Take a look at your P&L for the month, remove any staff costs already accounted for in the previous two steps plus any Corporation Tax payments or Depreciation charges if you have them
The costs left will be your overheads or expenses
If your costs are fairly stable, just take one month’s total and x12 for the annual figure; if your costs are more variable, use the totals from a quarter and x4 for the annual figure

Why:
Although not directly related to servicing your clients, the overhead expenses are vital to the running of your agency
By including these costs as well, we get a full picture of the agency spend across the year

Now we have figures for each of the different costs, let’s put them together and see what we’ve got:

This set of information can tell us quite a few useful things.

The percentage of costs that relate directly to client work - in service businesses this is almost solely staff salaries & the associated extras (PAYE, NI, pension, etc):

The average monthly cost to run your business, which means you now have a baseline to work from when setting sales targets:

The annual costs of running your business at its current level, which will help with aligning your turnover targets and forecasting plans:

Simply reviewing the costs of your business is a big step towards better understanding the  finances, but there are lots of other things you can do with these figures. 

One of the common metrics tracked in agencies is profitability. Now, every agency owner can tell you whether their business is profitable overall, but often the more granular profitability such as profitability by client or profitability by project isn’t being tracked. But why does it matter, I hear you ask, I know my agency is making money so what’s the point?

Maybe there’s not a point, if you are happy with the way things are then overall profitability may be enough for you. If you want more, then maybe you should dig a little deeper into those figures & see if you can answer those nagging questions:

There are numerous ways of looking at profitability, and you can make it as complicated and granular as you wish, but the most important thing is to ensure that you are actually making money once ALL of the costs are taken into account. Not just the staff costs or the cost of sales figures, everything from the monthly AWS bill to the toilet paper subscription.

To keep this simple, for now, we are just going to concentrate on hourly rates - does your business charge enough per hour to maintain the profit margins you need? Alternatively, if the work is fixed price, when you add up all of the hours used, is the equivalent hourly rate high enough?

We will take some of the information we have already and combine it with the data from your time tracking software and see what comes out the other end!

To start with, let’s use the Direct Staff Costs information from earlier to calculate the Hourly Cost of your billable team:

So, assuming your staff have enough work to do (and they’re not sat twiddling their thumbs for half the week!) each hour logged against a client costs the company approx £25.

That’s the direct staffing cost per hour, but we also have other costs to consider. Let’s refer back to the split of costs we worked out earlier:

So, once we take into account all of the costs needed to keep the company running smoothly, we know that every hour billed to the client costs around £39.08.

Now we have the cost per hour to run, let’s compare that figure to the amount charged for a couple of recent projects and see how they stack up…

The actual cost per hour is always going to be higher than the staff cost per hour and this is often where people undercharge. It is not enough to base your hourly rates solely on your staff costs, you must take into account the true cost of running your business otherwise you will sleepwalk into bankruptcy!

Also, just because a project brings in more cash, doesn’t mean that it makes more money for the business. The revenue for a £50k project may look good on paper, but if digging into the figures shows it only makes a 20% profit then you may be better off with several smaller projects, where each one makes a 40% profit. 

Obviously there are lots of factors to consider when choosing projects to pursue, not just financial ones. However, it’s worth bearing in mind that lower profits means less money available for dividends and, as an owner that relies on dividends to top up your income, too many of those “vanity projects” and not enough “profitable projects” can be disastrous!

These metrics & reviews are just a small part of what can be done when it comes to agency financial reporting, but hopefully they give you a way to get started.

If numbers really really aren’t your thing, maybe look to others in your team for help, or reach out to us and we’ll help get you on the right track.