Agency profitability refers to the financial gains an agency secures after all operational costs, overheads, and other expenses are deducted from its total revenue. It's a paramount metric for agencies as it not only reflects the organization's financial health but also indicates its sustainability, competitiveness, and growth potential in the market.
Factors that impact agency profitability
To master the nuances of agency profitability, understanding the influential factors is vital. Here's a breakdown of the primary determinants:
Client acquisition costs: The expenses associated with acquiring new clients, including marketing campaigns and sales efforts. Minimizing these costs can directly boost profitability.
Operational efficiency: Efficient processes and workflows reduce wastage of resources and time. Greater efficiency often translates to increased profitability.
Pricing model: The structure by which services are priced plays a critical role. A well-thought-out pricing model can enhance profit margins while ensuring value for clients.
Talent management and retention: The ability to attract, train, and retain top-tier talent is crucial. High turnover or ineffective talent management can inflate costs and reduce profitability.
Scalability of services: Agencies with scalable services can cater to varied client needs without proportionally increasing costs, leading to better profit margins.
)
)
How to calculate agency profitability
Calculating agency profitability provides a clear insight into an agency's financial health. Here's a step-by-step breakdown:
1. Determine total revenue: This is the gross amount the agency earns before any expenses are deducted. It includes income from client contracts, retainer fees, and any other streams of income.
2. Total up operational costs: These encompass all the costs involved in running the agency, including but not limited to:
Salaries and wages of employees.
Rent and utilities.
Marketing and advertising expenses.
Technology and software costs
Any miscellaneous expenses that the agency incurs.
3. Calculate gross profit: Subtract the total operational costs from the total revenue.
Gross Profit = Total Revenue - Total Operational Costs
4. Factor in client acquisition costs: These are the costs related to bringing in new clients. It can include advertising, promotional events, pitches, and any sales-related expenses.
5. Determine net profit: Subtract client acquisition costs from the gross profit.
Net Profit = Gross Profit - Client Acquisition Costs
6. Compute profitability percentage: To understand profitability in percentage terms, divide the net profit by total revenue and then multiply by 100.
Profitability Percentage = (Net Profit / Total Revenue) x 100
Utilizing platforms like Teamwork.com can assist agencies in tracking revenue and expenses efficiently, ensuring an accurate calculation of profitability. Our guidebook on mastering agency profitability will also benefit agencies who want to improve their bottom line.
)
Transparency leads to trust
If you want to create a culture of transparency at your agency, it has to start at the top. And while transparency alone isn’t enough to build trust between agency leaders and workers, it’s one important component of the equation. Your team is doing hard work and they deserve a clear picture of their impact. The numbers support this idea. In fact, in Slack's Future of Work study, 80% of employees wanted to know more about how decisions are being made in their organization, while 87% mentioned that they hoped their next job would be transparent.
Also, in AdAge's Best Place to Work survey, the winners received high marks in key areas including having "a good understanding of how this organization is doing financially." This research shows how being kept in the loop about the company's profitability is a massive contributor to overall job satisfaction.
)
Insights can increase productivity
Sharing real numbers with your organization gives team members a tangible way of measuring their performance and helps them find a connection between their work and the agency's overall growth.
Too much information, on the other hand, can cause your team to feel overwhelmed or disheartened. A tip here is to break the information into digestible pieces and try to put a positive light on the update. Even if your agency's profitability isn't where you'd like it to be, you can share information with your team in a way that is honest but allows them to feel optimistic and motivated about the future of the agency.
)
Sharing creates accountability and ownership
Treating your employees like owners in the sense that they have the same insight into profitability as you do can help your team feel more involved and take accountability for their contributions.
The author of The Great Game of Business, Jack Stack, used a principle known as open-book management. This is when management shares all financial information with all employees so they feel and act like owners.
)
Although some leaders have seen success sharing all data and finances with their teams, most would agree it’s too much for every day. During our Mastering Agency Profitability webinar with Megan Bowen, COO of Refine Labs, we picked Megan's brain and learned the three metrics that Refine Labs’ leaders pay the most attention to: Gross margin %, Net income, and EBITDA.
Gross margin % = Net sales - COGS (Cost of goods sold) / net sales
As Megan explains it: “Gross margin is really a reflection of the cost of goods and the structure you created to deliver your service. It’s really reflective of ‘Are we being efficient in delivering our service to our customers?’ That’s a key input, ultimately, to profit and net income and there are specific levers you can play with to influence gross margin, both positively and negatively. So, it’s something that we look at closely and something we want to continue to improve so we stay efficient and drive as much profit as possible.”
Net Income = gross income - expenses, such as taxes and interest
“At the end of the day, how much money is the business making? How much is being produced by the business?”
EBITDA: Earnings before interest, taxes, depreciation, and amortization
In Megan’s view, EBITDA “is another way to look at net income. It essentially allows you to look at net income and EBITDA and take things like interest payments or taxes and classify them a little differently to understand your core business expenses versus these other things that happen in the normal course of business.”
Additional profitability metrics to consider sharing with your team:
Gross profit = Net sales - Cost of goods sold
Gross profit differs from net profit as it only reflects the cost of goods sold, whereas, net profit includes all company expenses.
Net profit = Operating profit + any other income - additional expenses - taxes
Net profit is the profits your company earns after subtracting all company expenses such as operating, tax, and interest.
Operating profit = Gross profit - operating costs, including selling and administrative expenses
Operating profit is the net income that comes from a company's core business operations.
Keeping your team up to date with the company’s profitability is essential. It gives your employees the opportunity to really understand the company's overall profitability and how their work is making a difference in real-time.
When exactly you decide to share updates may depend on the size of your business. The smaller your agency is, the easier it is to share profitability updates with the team. As your business starts to grow – when you have more employees and the metrics become more complicated –there's more room for confusion.
When Refine Labs first started, Megan describes how simple and straightforward it was to walk through the metrics with the rest of the company. At this point, they would share updates on a monthly basis. Once the company expanded, there was more room for misinterpretation and confusion around the metrics. Now the company’s leaders hold quarterly all-hands meetings that focus on the key metrics covered above: revenue, expenses, and net income.
The best methods for sharing profitability metrics with your team
Once you know what you want to share, it's important that you do so in a way that's easy for every employee to digest and understand, whether they are in finance or marketing or customer support. Remember, not everyone is an accountant, so make sure you’re presenting the information in a way that’s clear and concise.
Use loom videos to explain metrics: When it comes to your profitability, you want to remove room for interpretation. Consider creating short loom videos that have voice-overs clearly explaining how to read and interpret the metrics.
Post to intranet: Make sure you have a secure and centralized place to share updates so employees can quickly find the information they are looking for. Megan mentioned that at Refine Labs they update their intranet monthly with definitions and explanations of each metric.
Use it as a learning opportunity for the team: Explain to your team that understanding these metrics will not only benefit them in their current roles but it is also an opportunity to advance their professional development. Understanding these metrics will help your employees advance their careers or one day start their own businesses.
Take the guesswork out of profitability with Teamwork.com
Where’s your organization at when it comes to measuring profitability? Do you know where you stand? Do you have efficient processes and systems in place for sharing financial information?
Teamwork’s Profitability Report allows you to capture your net profit with the click of a few buttons and see your remaining budget to determine the best next steps forward. Simply download PDF or excel versions of the report and then share it out, to keep everyone aligned and on track.
)