When you’re on a journey and you stop midway, what do you do next? Do you look back over where you’ve just been? Or do you look at where you’re going?
You look at the route ahead from the point you’re at. Not from where you started. And exactly the same principles apply to your agency. No business can be successful simply by looking at year-end accounts to see what they did last year. Yes, you can get a view of where you were, which can help with growth planning. But for the true picture, you need to look at where you are right now and where you’re going, so you can move in the right direction. Forward.
This is especially relevant as we’re seeing such big, fast-moving changes in the global economy. Pandemic aside, things move far too quickly these days for last year’s financial performance to be of much use or interest. Back to my journey analogy: you need to be looking in your windscreen, not in your rear-view mirrors. There’s a reason the windscreen is so big!
At the end of each month (or beginning of the next month), you should be reporting your actual figures against your targets, so you can see any variance and address issues quickly.
If things aren’t on plan, you don’t need to panic. Revenue can fluctuate month on month. You could have a super-high month, followed by a lower month, so overall they balance out. By tracking the trailing 12 months (TTM) – the past 12 consecutive months – you can see if this is a trend or an anomaly.
Tracking actual year-to-date (YTD) versus your target for each month too, will show you if you’re on course for the year. If things aren’t going according to plan, readdress your forecast on a quarterly basis.
Here’s what I’d recommend breaking down to look at each month:
1 – Income
The gross profit (aka sales profit or gross margin) from existing and from new business. And the fact it has so many names just adds to the fun/confusion! Gross profit is the revenue (aka turnover, sales or invoiced) minus any specific job costs or pass-through expenses, such as media buys, printing, job-specific contractors/freelancers or materials for a shoot etc. Don’t include your salary costs here, as they are an overhead. Split this by existing business and new business, so you see where it’s coming from and that you’re on track against your target each month and YTD.
2 – Costs
Break these down into salary costs, overheads and freelancer costs, so if any issues arise you can quickly see where.
Salary costs and salary ratio. As a service business, people are the biggest agency cost. Obviously, we need to make sure salary costs are below gross profit, so we’re earning more than we’re paying out. This should include directors pay and regular dividends – if you are working in or on the business this cost need to be included to normalise the profits – and any long-term contractors or freelancers. I usually recommend a ‘salary-to-gross-profit ratio’ of 55-65%. If your salary ratio is higher than 65%, you’re not making enough money. Either you have the wrong staff mix, inefficient processes or you’re not selling enough. So your profit is going to be down. If you have a lower salary-to-income ratio, your staff are probably overworked or underpaid. Remember, retaining the best people is a key part of agency growth.
I would also break out the non-revenue generating headcount, if your non-revenue generating headcount is more than 10% of your employee base then you need to look at the structure.
Overheads (minus salary costs). These are all the costs to run your business that can’t be traced to a specific job. Although salary and freelancer costs are officially overheads we take them out for reporting, so we can track any overspend.
Freelancer costs. This is really important, as we don’t always plan for freelancers. While you might be bringing in freelancers to keep your revenue high, your profits will go down because it’s an additional cost. By keeping track of freelance costs and numbers each month, you can quickly spot if you need to make changes because of IR35 or need to recruit permanent employees to improve profits.
3 – EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation)
Another one with many names, this is also referred to as ‘operating income’ or ‘operating profit’, because it’s found by deducting all operating expenses from sales revenue (income-costs). It’s an indication of how much profit you’ll be able to retain in that period, before corporate tax deductions and removes the factors that business owners have discretion over, such as debt financing, capital structure, methods of depreciation, and taxes (to some extent). You can use this to showcase your agency’s financial performance without accounting for capital structure.
If directors are taking monthly dividends, it’s equivalent to monthly salary, so I’d include this as an operating cost to give you a clear picture of retained profit.
EBIT (Earnings Before Interest and Taxes) is a variation of EBITDA. The key difference between EBIT and EBITDA is that EBIT deducts the cost of depreciation and amortization from net profit, whereas EBITDA doesn’t – making it simpler to calculate.
4 – EBIT percentage
Dividing EBITDA by sales revenue gives you your operating margin/profit, expressed as a percentage. You can then use this to evaluate your agency’s operating performance. If you want to benchmark performance, you can compare this margin to past operating margins or to those of other agencies. I recommend that agencies should be ambitious and aim for 20% EBIT or operating margin.
5 – Revenue (gross profit) per head aka profit per head, or revenue per employee (rev/FTE)
Don’t you love all these names? It’s a great metric to track your teams’ overall productivity and you can use it to measure the performance impact of improvements over time. It’s calculated by dividing revenue by your full-time equivalent (FTE) number. If someone works full-time, they count as 1.0 FTE. If someone works half-time (eg 20 hours in a 40-hour workweek), they’re 0.5. Be sure to include any contractors who do work on a regular basis (eg someone who works 10 hours every week would be 0.25 FTE, but you wouldn’t count a contractor who’s paid for a single-brief project). For most agencies, you should be aiming for £100,000 gross profit per head. If it’s lower, you should try to increase revenue without increasing your team, increase staff utilisation and/or decrease your team size.
6 – Recoverability
This tells you how much you’ve billed against how much you could have billed each month. First you need to calculate your total number of chargeable hours each month, keeping it realistic. Multiply that by your average hourly rate to give you a revenue value. Next, compare this to your actual income to give you a percentage recoverability figure. Ultimately, the higher the rate, the more profitable your business will be. So if you’ve targeted £80k gross profit with 90% recovery, have you achieved this? If recovery was below 90%, you’re not going to hit your target for the year. You can then look to pinpoint why recoverability isn’t on track, such as underutilisation, overservicing or underquoting.
These six core practices give you the ultimate finger on the pulse of your business. You can see what profit you’re forecast to make, where you’re heading and what you can do to improve things. It’s about making the right decisions right now to transform your agency’s future fortunes.