Running an agency is tough. Be it for software development, design, or marketing, the demand is ever increasing—as is the competition.
Between meeting client expectations and balancing hiring and sustainable growth, the last thing you need to worry about is eroding profit margins, or worse: not having a clear picture of where your agency stands in terms of profitability.
That’s why we respond to some of your most vital questions: how do you calculate agency profit margins and, even more importantly: how to increase your agency profit margins?
What Is an Agency Profit Margin?
Agency profit margin is generally calculated by looking at your company’s profit (client revenue minus all your operating costs) divided by revenue (commissions, fees, incentives, and other remuneration).
How To Calculate Agency Profit Margins
As an agency, you’re constantly battling with unforeseen costs and changing budgets, so calculating your profit margins can be extremely difficult.
Remember that client that earned your agency $1000 profit at a 25% margin? Add in an extra few unprecedented revision requests from that same client and your profit drops to $500.
To be able to make informed strategic (and tactical) decisions, first you need to know your agency’s actual profit margins.
In BenchPress 2021, a survey conducted by the Wow Company, only 80% of UK agencies said that they made a profit in 2020, while 14% made a loss and 6% broke even. According to the Wow Company’s survey, average gross profit margins are 44%, while agencies should aim for a gross profit of 50% or more.
In the same survey, what was interesting to find was that over 61% of agencies received funding in the same year. These numbers indicate that it’s key to improve how you manage your agency profit margins.
“Being profitable is the cornerstone of a sustainable agency. Whatever plans you have for your future, you won’t get very far if you’re not making any money.”— BenchPress 2021
To get an idea of what your profit margins should be, you need to enter all your expenses into your agency management tool: people expenses, overhead costs, and any additional expenses your agency generates. Let’s take a closer look at each.
1. People costs (salaries and such)
Entering your employee costs into Productive is one of the first and most important steps towards getting a clear picture of your profitability. Adding in their number of working hours per week and monthly salary will give you their estimated hourly cost.
When your agency lands a new deal and you don’t have enough in-house resources to deliver the work, you reach out to your freelancers. Add them into Productive as out-of-pocket expenses within the budget of each project.
Overhead costs are not only your fixed and variable company expenses. In an agency’s case, overhead expenses are all your agency’s non-billable costs, too. These can be:
- HR employee salaries
- Office management salaries
- Marketing budgets
- Accounting services
4. Any additional expenses
Hiring seasonal support or organizing a PR event as your own promotional activities can be seen as additional expenses.
Once you’ve got all your costs saved in your agency management system, you need to consider what your utilization rates are and how to form prices that will not only cover your expenses, but increase your agency profit margins.
Why You Shouldn’t Calculate Agency Profit Margins in Excel
Let’s take a look at an example of how John Smith used to manage his profitability in spreadsheets and why you shouldn’t calculate agency profit margins in Excel.
First, John had all his project budgets and people costs in Excel:
He thought he was handling things well and that he had a clear overview of his profitability.
Soon, some additional, unforeseen bills started coming in per each project, and as they came, he kept adding them to his expenses:
One day, John realized that he should add in all his agency’s overhead expenses, so he did that, too. But a few months later, what seemed like a project that would earn a 40% margin, turned out to be 18%. Why?
John dug deeper into his expenses and team’s utilization and realized a few crucial things:
- Firstly, some of the teammates that he assigned to this project were too expensive for this particular project to make a higher profit.
- Secondly, there were additional overhead expenses that he hadn’t factored into his expenses at the beginning.
All this led to an even lower profit margin of 9% on this particular project.
And so John decided: I need to be able to monitor my profitability per client and project in a system that will factor in all my expenses, overheads, and additional costs and generate real-time reports that will tell me what to decide next.
“I used to be stuck in Excel every day, and it sucked. Now it’s quite cool, coming into work. My day has improved, every single day, from every single perspective. As a project manager, it definitely gave me more confidence to make decisions because I’ve got the data to do it now.”— Patric Osburn, Service Operations Manager at Quintica
Read Quintica’s journey with Productive here.
How To Maximize Billable Time to Increase Your Agency Profit Margins
To figure out how much you should charge, you’ll want to answer the following question: what are your agency’s actual utilization rates?
Maybe you’re already using a few tools to combine data and figure out your utilization rates. Maybe you don’t have utilization data available at all.
There’s no unified way of measuring your utilization rates, but one thing is for sure: it’s necessary for employees to track their time for both billable and non-billable work in a tool that will then show you how well they’re being utilized.
Generally, employees in agencies tend to work an average of 120 hours per month, which is around 1,440 hours per year (including vacation, sick leave, training, etc.) By looking into the utilization of your employees, you can see how well they’re performing and whether they’re allocated to the right types of services. If your actual utilization per employee is around 75% on a yearly basis, that’s a pretty good result.
Find out more about the most important metric for your agency business.
Once you have a clear picture of your utilization rates and all your expenses, it’s time to use a simple, yet proven formula to calculate how much you should charge for your agency services.
Basically, what you need to do first is take an employee’s gross monthly salary, multiply is by 12 months, and multiply that number by three. Like this:
What you have now is the gross annual salary of an employee multiplied by three.
Then, divide each employee’s gross annual salary by effective working hours per year. Let’s say the number of effective working hours is 1,440 on average for a 40 hour workweek. When you divide the gross annual salary by hours worked, you’ll end up with the hourly rate you need to charge so your agency can make a profit.
“In order for a company to be profitable, a worker must cover the cost of his annual salary, times three. This is popularly called one salary for you, one salary for the company (overhead), and one salary for the boss (profit). The fact is, agencies have a lot of hours that are non-billable, which still need to be covered. All these hours that add up should be covered by the so-called Times Three Model.”— Ilija Brajković, CEO of Kontra
Using One Tool To Increase Efficiency and Agency Profit Margins
Having a single point of trust for all your financial data, leads, budgets, and project communication helps you increase agency profit margins by reducing the amount of time that typically gets wasted on:
- Unconsolidated communication regarding projects and tasks across multiple tools
- Resource planning data in 2-3 systems
- Financial insights in multiple places
- Administrative work connected to invoicing and payroll in different platforms
Profitability insights in Productive include your overhead, employee cost rates, and any additional expenses, which give you real-time margins. Continue reading to see how.
How To Monitor Agency Profit Margins in Productive
In Productive, you don’t need to calculate your agency profit margins because profitability reports automatically do that for you.
Here’s a quick breakdown of how to calculate your agency’s profitability in Productive:
- Add all your employees and their salaries into Productive.
- Add in all your clients and projects, including how much they pay you for your services (choose from different options: fixed monthly rates, monthly hourly rates, fixed rates).
- Add your overhead costs if you haven’t already.
- Once your project kicks off, your employees need to track their time on a daily basis.
- Managers will determine whether these hours were billable or non-billable and approve them or request changes.
- Productive automatically calculates the profitability of each project and client and tells you what the cost of overhead (fixed + variable) is, per hour. It also calculates overhead per working hour, per project, and factors it in—giving you your profit in real time.
“From a business level, now we make better decisions regarding our utilization. I’m understanding new things about profitability. I’ve made certain assumptions before, and some of those assumptions have proven to be wrong. For some projects, we weren’t sure how far over budget we were, and now we can really see.”— Roberto Ciarleglio, Co-founder and Managing Director of Contra Agency
Want To Increase Your Agency Profit Margins?
Here’s what you should take away from this post:
- If your agency profit margins are too low, consider adopting value-based pricing, reevaluate your utilization rates per employee and rethink your current resource planning;
- Use a proven method for calculating how much you should charge for your services;
- Factor in your non-billable time as overhead.
Without one tool to manage your agency, it’ll be difficult to set your business up for success. Schedule a demo call with our team to learn how Productive can shape your agency’s future.