When agencies grow, their profits don’t necessarily go up. Many make the — understandable — mistake of chasing increased revenue, without taking costs into account. In some cases, this can lead to increased growth and reduced profits, not a scenario any agency wants. But, with some effective cost forecasting, you can get a far more realistic picture, helping you to plan accordingly.
You’re expecting an extra £200k in new business, which is brilliant news for your agency. But while you’re thinking about the revenue, don’t forget about the costs. You won’t be able to deliver this level of business without some extra expenditure. Once you consider pitching costs, travel, freelancers or new recruits, IT, office space, coffee, milk… you literally need to think about everything you’re going to spend and make a cost forecast.
A cost forecast is a realistic plan of costs for each period — month, quarter or year — based on what’s needed to achieve your objectives and plans. Once you know how much it’s going to cost you to run your business, you’ll also get a realistic idea of how much profit you could make. This helps make sure you have enough money upfront to deliver the business.
Most agencies know roughly how much it costs to run their agency each month on average. But costs vary quite significantly month-to-month. For example, some months will bring bigger bills than other, and costs will change as you grow.
It’s important to get right down to the granular detail of your costs. Look at all overheads line by line – salaries, freelance costs, recruitment, rent, insurance, utilities, rates, milage, travel, entertainment, marketing, etc. Then make your forecast line by line.
Remember, you still have to pay your staff even if you don’t make sales, so I’d recommend including these as an overhead. For freelancers, if it’s for a one-off job these can be classed as a cost of sale, but if they’re on a contract include them as an overhead.
Impacts and scenario planning
Effective cost planning helps you understand the impact of any big purchases, such as taking on new staff or moving to a new office. It can also be used for scenario planning, creating plans based on different scenarios. For example, you can compare the costs of hiring a new staff member vs using a freelancer and then make an informed decision.
There are two ways for agencies to grow their profits and earnings before interest and taxes (EBIT). You either need to increase revenue and keep costs the same, or keep revenue the same and reduce your costs.
It’s a good idea to do a detailed cost forecast at start of the year. Break it down into salary costs, overheads and freelancer costs, so if any issues arise you can quickly see where. Then track your actual costs against your forecasted costs each month to make sure your projected profit and salary ratio is on target for the year (I usually recommend a salary to gross profit ratio of around 65%).
If things aren’t going according to plan, readdress your forecast on a quarterly basis. Sometimes things happen that are beyond your control, like your landlord giving you notice or an increase in costs from a utility provider.
Agencies can see a period of growth and their profits dip at the same time, which can be disheartening. But by making an accurate cost forecast which you regularly review, you can see how and where you can build efficiencies. As with most things agency-related, it’s all in the planning…