Financial reporting for agencies

Retainers and projects behave differently

Most agencies earn money in two ways: recurring retainers for ongoing work, and one-off projects with a defined scope. Both are good business, but they need different treatment in the books.

A retainer billed at the start of the month for work delivered during that month is fairly simple. It becomes more involved when retainers are billed in advance for a quarter, or when unused hours roll over. For example, if a client pays a $15,000 quarterly retainer upfront, a reasonable approach is to recognise $5,000 per month as the work is done, holding the rest as deferred revenue. Projects might be billed in milestones, such as 40% upfront and the rest on delivery, which again means cash and earned revenue won't line up month to month.

Separate revenue accounts, or at least consistent tags, for retainer and project income let you see how much of the business is predictable and how much has to be won again each quarter.

Pass-through costs can distort the picture

Many agencies buy things on behalf of clients: media, printing, stock assets, freelance specialists, event costs. These are often billed back at cost or with a small markup. If they are mixed into revenue without care, the agency looks much bigger than it is and margins look thin.

Suppose an agency invoices a client $50,000 in a month, of which $35,000 is advertising spend placed for the client. The agency’s own fee is $15,000. Reporting $50,000 of revenue and $35,000 of cost is technically one presentation, but for management purposes the number that matters is the $15,000, sometimes called net revenue or agency gross income. Whether pass-through costs must be shown gross or net in formal financial statements depends on the arrangement, and is a question for your CPA.

Whatever the presentation, track pass-through costs in their own accounts. That makes it easy to check that every dollar spent on a client’s behalf has been billed back.

Client and project margin

Agency-wide profit tells you whether the business works. Client and project margin tells you where it works. To get there, each client or project needs its revenue and its direct costs, mainly the cost of the people who did the work.

Take a hypothetical client paying $12,000 a month in fees. The team logged 100 hours on the account, at an average loaded cost of $55 an hour, so $5,500 of labor. Add $500 of direct software and freelance costs, and the client margin is $6,000, or 50%. Another client paying the same fee but consuming 170 hours tells a very different story. Without margin by client, both look identical on the P&L.

Project margin works the same way, and it is most useful when compared with the original estimate. If a fixed-fee website project was scoped at 200 hours and took 290, the overrun shows up as lost margin. Reviewing finished projects this way, honestly and without blame, is one of the quickest ways to improve future quotes.

Utilization inputs

Utilization measures how much of the team's available time goes to client work. It isn't a bookkeeping figure on its own; it comes from time-tracking. But it becomes far more useful when it sits alongside the financial reports.

The finance side supplies the cost per hour, including salary, benefits and employer taxes, and the revenue per client. Time-tracking supplies the hours. Together they answer questions neither can answer alone, such as whether a team is busy but unprofitable, or profitable only because people are working unsustainable hours. Expect targets to vary by role. A creative director who spends much of the week on new business and team leadership will rarely match a production designer's billable hours, and shouldn't be expected to.

• Capacity: the total hours each person is available, after holidays and leave.
• Billable hours: time spent on client work, whether or not it is billed by the hour.
• Utilization rate: billable hours divided by capacity. If someone has 160 available hours and logs 112 on client work, that is 70%.
• Effective rate: fee revenue divided by hours spent, which shows whether fixed-fee work is priced well.

Keep a close eye on AR aging

Agencies often carry large receivables, especially with bigger clients on long payment terms. A receivables aging report sorts unpaid invoices by how long they've been outstanding, typically in buckets of current, 1 to 30 days past due, 31 to 60, 61 to 90 and over 90.

Clear payment terms in contracts help, and so does invoicing promptly. An invoice sent two weeks after month end is, in effect, two extra weeks of credit you gave the client without meaning to.

Review it monthly, and look beyond the total. A single client with $40,000 sitting in the over-60 bucket is a concentration risk, especially if your team keeps working on their account. Agree on who follows up and when, and pair the aging report with the margin report so that slow-paying clients are judged on both. Sumday’s agencies page and accounts receivable service describe how we support this reporting.