Part Two:
In the first part of this series, I laid the foundation for the importance of time and client P&L calculation. In this post, I will cover Client P&L Analysis, Billing Time Calculation, and Billing Time Analysis.
So now that we have spent all this “time” telling you how to arrive at a client P&L, here is what should be of analytical interest to the agency.
When reviewing the individual client P&Ls in summary, they should be compared to the three industry-standard percentages, labor 50%, overheads 30%, and profit 20% against AGI. If your clients are not earning 20% in profit for you, it is important for the well-being of the agency to find out why.
What you will uncover is some interesting information to digest.
You’ll find very profitable clients where the labor is in line. You’ll discover a number of clients where the labor percentage is much more than 50% against AGI, and those clients are losing money. If you also find profit swings (month over month) between clients, it’s time to take a deeper dive into why this is happening.What is the objective of this Client P&L analysis?
To determine what your ROI is with every one of your clients and to reflect.
Ask yourself some questions:
At its heart, the agency should understand its clients' internal financial metrics and not just worry about getting the client invoice out and billing the client for services rendered.
Consequently, a direct comparison of the Client P&L to the Billable time report must also be reviewed.
What could we have billed to the client vs. what did we actually bill to the client?
More and more clients tell me that they don’t enter time.
They prepare an estimate and live and die by it. That is their reason not to enter time. Makes no sense to me or…they don’t know (or care for that matter) what they don’t know from an agency financial metrics standpoint.
Yet, there is the other side of the coin to consider. For all that an agency does today, it is about being internally accountable for their time.
What do I mean?
Let’s first define billable time.
At the heart of this is the value of each hour.
Whenever I visit an agency, they usually start with, “Vince, around here, we do things a little differently here…”
As a result, I see many types of hourly billing rates: blended rates, by service type, by employee, what the market will bear, what the client is prepared to pay per hour, and even made-up rates.
In some cases, I have seen some agencies that have not increased their rates in five years, yet oddly enough, they give annual salary increases to staff. In essence, many different external billing rates exist in the industry.
What defines an external billing rate? It should be high enough to cover labor, overheads, and profit unless you are desirous of being a charitable organization, which I wonder about some agencies.
When I help agencies set or reset their external billing rates, we start with the employee's hourly cost (covered in the labor cost section of the client P&L calculation) and multiply it by at least three times.
This multiple covers the cost of the employee, overhead, and profit.
Depending on your services, the multiple may be upwards of 4 and 5 times as well. However, if you set your external billing rates too low, you risk not earning a company-wide 20% profit.
There are two reasons to enter one’s time into a client project;
Why? For management reporting purposes, it is important to compare the difference between AGI billed and earned on a client project vs. what could have been billed, especially if there is a material difference between the two figures.
For example, if you provided a client with an estimate for $50,000 and the billable time was $75,000 on the job, but you could only bill the $50,000, one could interpret this $25,000 in what could have been earned additional revenue as the opportunity lost to earn revenue against another client project OR consider it a write-off.
It should be part of the month-end management reporting review to see how much of this revenue was not earned or simply put, written off by write-off category by job, job type, client and employee.
It is important to do so to determine if there is a pattern for these overages, mostly to course-correct a client's internal workings and even improve the estimation of certain types of jobs.
Years ago, I visited an agency, and the owner proudly showed me a 10% operating profit of $600,000 on his income statement. He was so proud of that figure. I then asked to see the write-offs report and he had no clue about such a report. I turned to the controller and asked the same of him, and moments later, he brought it back to me. The write-offs for the year in question, oddly enough, came in at $600,000. It was the first time the owner saw such a report.
After resuscitating him, I asked him to pay equal attention to the revenue dollars that were being written off moving forward as his income statement. Today, this agency is north of 25% in operating profit.
At this juncture, I cannot emphasize enough the importance of accurate time entry for both costing and revenue-earning purposes. With all that being said, it is important to ensure that a consistent external billing rate is understood by everyone in the agency, especially those who are internally accountable for maximizing not only the profit per client but also the AGI per client.
When was the last time you adjusted your external billing rates?
So, what is more important to review: client P&L or Billable Time Reports?
I’m a big proponent of managing by exception.
For those clients who are doing just fine and humming along with a more than sufficient profit, use your client P&L. Naturally, both reports should be used for the loss clients and high labor percentage clients.
Happy analyzing!