If you’re like many business owners, there are aspects of running your agency that you find straightforward and others that can be a bit challenging.
Take Sam Walton, the founder of Walmart, for example. Despite not being the most organized and never keeping a schedule, he was incredibly focused on understanding the financial performance of his stores.
He knew exactly how each store was doing at any given time, which was crucial to his success.
For digital agencies, understanding your Profit & Loss (P&L) statement is just as critical. It’s not just a document you should be familiar with—it’s a key tool that helps you see how your business is performing and where you might need to make adjustments.
But what should you be looking at every month? What are the most important parts of the marketing agency P&L to dissect?
In this blog, we’ll break down the main sections of the P&L for digital agencies, and give you some practical tips on how to handle certain topics.
Let’s dive in.
What Goes Into An Agency P&L?
First things first, let’s talk about what goes into your Profit & Loss Statement (P&L) and how it should be structured.
Here’s the typical outline of a P&L statement for a marketing agency:
Revenue
This is the total income your agency earns from its services, including fees from retainer clients and project-based work.
Cost of Goods Sold (COGS)
These are direct costs associated with delivering your services. For agencies, this often includes salaries for billable staff and any expenses related to client projects.
Gross Profit
Calculated by subtracting COGS from revenue. This shows how efficiently you’re using your resources to generate income.
Operating Expenses
These are the costs required to run your business that aren’t directly tied to client work. Common categories include:
- Payroll for Non-Billable Staff: Administrative and support staff.
- Advertising Spend for Your Agency: Marketing costs to promote your own business.
- Software & Tools: Subscriptions and licenses for operational tools.
- Rent and Utilities: Costs associated with running your office space.
Operating Income
Calculated by subtracting operating expenses from gross profit. This reflects the profitability of your core business operations.
Other Income and Expenses
Includes any additional financial activities that aren’t part of your regular business operations, such as interest income or losses.
Net Income
The final figure after accounting for all income and expenses. This shows the overall profitability of your agency.
Let’s look at a few of these sections in more detail, starting with revenue.
Your Agency P&L: Revenue
We don’t need to spend too much time here. Revenue is the top line of your P&L and the part you’re likely most familiar with. It represents the total amount of money your agency earns from its operations.
At the risk of stating the obvious, the most important thing to monitor every month is whether your revenue is trending upwards. A steady increase in revenue usually indicates that your agency is growing and performing well.
Other than that, you may also want to focus on the breakdown of your revenue sources. Are you earning more from retainer clients or project-based clients? Retainers, which are regular, ongoing payments from clients, provide more stability and predictability compared to one-off projects.
This stability can reduce the financial stress on your agency and help with better financial planning.
Your Agency P&L: Expenses
Next, let’s tackle expenses. This section is likely the largest part of your P&L and the most complex.
While there are many categories that go into the expense section, there are a few in particular that we recommend monitoring closely:
Payroll / Labor
Payroll is often one of the largest expenses for an agency, and often debated among accountants about how to handle it on your P&L.
Here at Agency CPAs, here is how we recommend breaking it down:
- Billable Staff (e.g., Account Managers, Creatives): These are employees who work directly on client projects and their salaries should be part of your cost of goods sold (COGS). Without these employees, you couldn’t deliver the services your clients pay for.
- Non-Billable Staff (e.g., Administrative, HR): These employees support the business in other ways, such as HR or admin roles, but don’t necessarily deliver work to the clients. Their salaries are typically classified as overhead expenses. Under Operating Expenses.
- Contractors/Freelancers:
- US-Based Contractors: Often categorized as COGS.
- International Contractors: Even if they work full-time hours, they are typically considered COGS due to their episodic nature.
- Outsourced Services: Usually categorized as overhead.
- Foreign Full-Time Employees: These employees, although based overseas, function like in-house staff. Their compensation should be included in AGI, similar to domestic employees, due to their integral role in your operations.
Advertising Spend (For Your Agency)
This includes costs associated with promoting your own agency, such as online ads or sponsorships. Track these expenses separately from client-related advertising to get a clear view of how much you’re investing in your agency’s growth.
Example: If you spend $5,000 on social media ads to attract new clients, that amount should be recorded as part of your marketing expenses, not as part of client-related costs.
Advertising Spend for Clients
These are costs incurred for client projects, like media buys or influencer fees. These should be classified as COGS since they are directly related to delivering services to your clients.
Example: If you spend $10,000 on a Facebook ad campaign for a client, that $10,000 should be tracked under client-related advertising expenses.
Software & Tools
These are essential for running your agency but can add up quickly.
Regularly review your subscriptions and tools to ensure they are still necessary and that you’re not paying for anything you don’t use.
Example: If you’re paying for multiple project management tools but only actively using one, consider canceling the others to save on costs.
Owner’s Compensation
Owner’s compensation is another critical line item in your agency’s P&L, as it represents the salary or distributions paid to the owners of the agency.
Note: How you categorize and manage this expense can significantly impact your financial reporting and tax planning.
There are generally two components to consider:
- Salary: If you’re actively working in the business, your salary should be recorded as an expense under operating expenses. This makes it clear that you are being compensated for the work you contribute to the agency, similar to any other employee.
- Distributions/Dividends: Any profits taken out of the business as distributions or dividends should be recorded separately from salary. These are not operational expenses but rather a distribution of profits, and should be accounted for below the operating income line on your P&L.
For clarification, it’s a good idea to talk to an accountant who understands how agencies work. They can help you make sure that you’re handling owner’s pay correctly on your P&L. Getting this right can make a big difference in how your finances look and how much tax you have to pay.
Other Category
After revenue and expenses, you might see “Other Income” and “Other Expenses” categories, which contain income and expense amounts that are not part of operating your agency.
These items generally don’t change much — often, your only Other Income item is interest income from your bank accounts, and if you have anything in Other Expenses, it’s likely just taxes and interest expense.
These items are the effects rather than the causes of significant business decisions you make: how much cash to keep in your accounts, how much to spend on assets, and how much debt to accumulate.
Net Income
Finally, let’s talk about Net Income, which is simply your Total Revenue minus your Total Expenses.
Ideally, your net income is positive, meaning you’re “in the black” rather than “in the red.”
Net Income = Total Revenue – Total Expenses
One more thing about Net Income: It’s essential in calculating your Profit Margin:
Profit Margin = Net Income / Total Revenue
You might hear people talking about “good margins” or “strong margins.” This refers to how much of your revenue turns into actual profit.
In other words, what percentage of the money you earn from clients stays in your pocket after covering all expenses?
While some industries boast profit margins in the 20-30% range or higher, agencies often have more modest margins, typically around 10-20%. We wrote a more in-depth blog about agency profit margins here.
Ultimately, profit margin is the key metric that shows how effectively you’re turning revenue into profit.
Download Your SAMPLE P&L for Agencies
Finally, the best part. You can download our sample agency P&L to use in your business.
Note: this P&L is purely for example purposes.
You should work with your experienced agency accountant to customize it for your unique situation.
Have more questions?
Need More Help With Your Agency P&L?
Your accountant usually handles your agency’s P&L statement, using financial records and transactions to create and update it regularly.
However, it’s important for you as an agency owner to not only rely on your accountant, but also understand and review the P&L statement yourself.
This helps you make better decisions about your agency’s finances, spot any potential problems, and find opportunities for growth.
If you’re looking for an accountant with experience in the agency field or just want to explore other options, we’re here to help.
Head over to our Contact Page to schedule a quick introductory call with one of our agency accountants to discuss any questions or concerns you might have.
Otherwise, check out our previous blog on 5 KPIS to Track as an Agency Owner—we think you’ll find it useful!
Until next time!
