I meet many agency owners every year and whether they’ve been in business for a year or a decade — one thing is almost always true. They don’t really understand their financial reports.
In fact, many agency owners don’t bother looking at their financial reports. They may watch money in and money out…but that’s about it. Some will track sales or monitor clients who are taking a long time to pay their bills. But very few agency owners know what financial metrics they should be measuring and why they matter.
The vast majority of agency owners grew up in the agency business. Unless they had a particularly savvy boss who believed in a relatively open book policy — they were never taught how an agency makes money.
I know that sounds crazy — we all know that agencies make money by billing clients.
· But which clients are profitable?
· How much do you need to bill a client to actually make any money?
· How much of your billings is actually just pass through to vendors?
· What percentage of your billings should be spent on your employees?
· Will your billings tell you if you are under or over staffed?
These are the kinds of questions that most advertising, marketing, PR, design and digital agency owners don’t know how to answer. And these are the kinds of questions that will determine whether or not your business is still viable in three years.
One of the reasons that agency owners don’t have a handle on their business’ financial picture is because most agency folks are not numbers driven. They love the strategy or the creative side of the business. They didn’t get into the agency game to be a numbers cruncher.
But the big reason small- to mid-sized agency owners aren’t as well versed in the financial metrics as they should be is because the #1 metric used by the advertising industry is completely irrelevant.
Turn to any publication or story about advertising agencies and the first thing they’ll tell you about a specific agency is the size of their billings. In fact, AdAge and AdWeek rank agencies by their gross billings. They use that one number to indicate the size and breadth of an agency.
Truth be told — that number doesn’t mean anything more than how much cash flowed through the agency’s bank account. It doesn’t tell you if they’re profitable, if they’re over staffed or if they’re about to run into a financial brick wall.
I’d liken it to being impressed by someone’s palatial home only to discover they have folding chairs in their living room. Don’t get fooled by the bigger is better game.
At Agency Management Institute, we teach all of our agencies the financial dashboards and metrics that truly indicate the relative health of their agency. But we always start with AGI.
AGI or adjusted gross income is an agency’s gross billings minus their cost of good sold. AGI is the money that an agency actually gets to spend. For an agency that is still buying a lot of traditional media, their AGI may be 20-25% of their gross billings. For a PR shop, the AGI may be 60-75% of their gross billings.
So if each of those shops had gross billings of $5 million dollars. The traditional shop would actually only have about $1 million to operate their business but the PR firm would have $3 million.
Two very different scenarios with the exact same gross billings.
That’s why the metric that most agency owners rely on is meaningless. How much your agency bills in any given period of time doesn’t give you any intelligence in terms of how to run your shop.
It’s not what you bill. It’s what you get to keep that matters.
The number you need to know is your AGI. The number you need to grow is your AGI. The number that will drive your staffing and profitability and most other financial decisions — AGI.