There’s nothing sexy about agency finances. It’s probably one of the reasons why many agency owners don’t pay as much attention as they should. But while spreadsheets and ratios may not have a lot of sex appeal — vacation homes, fat college tuition funds and not having to worry about retirement sound pretty sexy to me!
So it’s time to put the sexy back into your spreadsheets!
In my last article, I discussed why the most common financial metric used in the advertising agency business (gross billings) is completely irrelevant to agency management, especially agencies with 200 or fewer employees.
Since the average agency in the US has eight employees — clearly we need to find a better way to monitor and measure the financial health of agencies.
Gross billings is a misleading metric because that number is so drastically altered by whatever the agency’s cost of good sold is. For agencies that buy a lot of traditional media and live on their 15% commission the world looks vastly different than a PR agency, who may get to keep seventy-five cents of every dollar they bill.
So if gross billings is not the answer — what is? At Agency Management Institute, we teach agency owners about AGI or adjusted gross income. You get to your adjusted gross income by subtracting your cost of goods sold from your gross billings.
Gross Billings - Cost of Goods Sold = Adjusted Gross Income
Another way to look at adjusted gross income is this. It’s the only money the agency owner gets to keep and spend how they see fit. It needs to cover the people (salaries and all benefits), the overhead and hopefully leave some money left over for a net profit.
To have a financially healthy agency, you must manage your shop by AGI. You may be moving millions through your checking account but you can only make business decisions based on the money that’s yours to keep. Many agencies have gotten themselves into significant trouble (read bankruptcy and lawsuits) by dipping into money that was really owed to a TV station or printer.
Looking at your AGI becomes a monthly calibration, to make sure your agency stays in balance. Your loaded people expense (salaries, benefits, any/all expenses and taxes related to employees) should be between 55-60% of your AGI. Your overhead should be between 20-25% and that leaves your EBITA (earnings before interest,, tax and amortization expenses) at about 20%.
When those ratios are out of whack, you know something in your shop is out of whack. If your payroll number is 65+%, you’re overstaffed for your billings. So you either need to get some new business in a hurry or you need to reduce your team. Overhead is high? It might be a one-time aberration like a move or big purchase. Or it might mean that everyone’s going a little heavy on those work lunches.
If you’re running an agency and want to pay attention to a metric that actually matters to your shop — it’s the AGI 55-25-20 ratio. Fall into those ranges and you know it’s going to be a good year.