Back in 2011, I launched into agency life full-time (and then some) after graduating from college. Despite working a crazy amount of hours, my tax return showed a personal income (including my share of business profits) of less than $20,000.
That income number more than doubled in 2012, but I was still running an agency, investing a ton of time and energy, and still doing it all for less than $50,000 pre-tax. I've made a lot of conscious decisions in life to not "chase the money," but if I'm going to pour so much of my life into an agency, I'd like it to be worth my time financially as well.
I've spoken with a lot of agency owners who are struggling to even come close to the income they'd like to earn. As a lot of business owners quickly discover, making money isn't easy and keeping that money is substantially more challenging.
At GuavaBox, it took us 3 years to finally get a sustainable business model in place. We needed to prove that we could acquire, service, and retain customers profitably. By mid-2013, we finally had a business that was attracting and keeping clients, covering team members and overhead, and producing worthwhile profits for the bottom line.
There are agencies who achieve profitability a lot sooner, and some who take longer. Then there’s a whole other group of agencies who couldn't tell you whether they're truly profitable or not. There's a good chance that those agencies are essentially paying for the privilege of serving their clients.
Do you know which subset of agencies you fall into? If you're not sure, the first question to answer is simply:
What does it mean to run an agency profitably?
By running a "profitable" agency, I mean that you're receiving enough revenue to cover overhead, team compensation, paying any owners who are working in the business a realistic salary (if it's not technically a salary, figure in taxes/benefits), and still having some meaningful amount of profit left at the end of the year.
Back in 2012, I might've initially said that we were running a profitable agency. We had revenue to cover overhead, personnel, and show some net profit at year end.
So what was the problem?
As I mentioned, I was working a lot of hours (we all were) and playing major roles in marketing, business development, client services, operations, and finance. There's no way that we could've hired the right people to replace my input for ~50K. It would've been much more expensive and wiped out the business profits (and more). My partner, Andrew, was in a similar situation — which compounded our unprofitability.
Is it bad if my agency isn't profitable?
I shared the GuavaBox example above for two reasons:
- To clarify how an agency with a "net profit" could still, in reality, be "unprofitable."
- To communicate that I've been there, I can relate to the challenge, and it's okay (for a certain period).
Ideally, you'd be able to bootstrap an agency and make so much profit right out of the gate that you could scale, build the infrastructure you need, make an above-market salary, and still have 25% net profit at the end of the year.
But I don't know any agency owners who have done that.
The first 2+ years at GuavaBox were filled with lessons as we discovered our identity, hired the right people, built the required infrastructure, and learned how to sell, deliver, and delight our customers. All of those lessons (which never end, by the way) cost money and took time, but they helped set the stage for a truly profitable agency to emerge.
Hopefully you're on an accelerated track to profitability, but don't be too hard on yourself if you're not there yet. The important thing is to understand the requirements for profitability, set your goals, and craft and follow a specific plan to get you there.
What metrics should I be tracking?
Drew McLellan from Agency Management Institute has nicely summed up my favorite way to measure profitability: Adjusted Gross Income (AGI — your gross revenue minus your cost of goods sold), and target expense numbers with the AGI 55-25-20 ratio.
"Your loaded people expense (salaries, benefits, any/all expenses and taxes related to employees) should be between 55-60% of your AGI,” McLellan wrote in a blog post. “Your overhead should be between 20-25% and that leaves your EBITA (earnings before interest, tax, and amortization expenses) at about 20%."
A lot of agency owners in the past have emphasized keeping your personnel costs under 50% of AGI, but I prefer Drew's breakdown. If there's one area to "overspend" on, it's your people.
Here's what this breakdown might look like on your books:
- Gross Revenue (Billings): $600,000
- Cost of Goods Sold (COGS): $100,000
- Adjusted Gross Income (AGI): $500,000
- Fully Loaded People Expense: $275,000
- Overhead Expenses: $125,000
- Net Profit/EBITA/EBITDA: $100,000
What you need to realize as an agency owner is that your own compensation needs to be figured into your people expense. The EBITA is business profit, not your personal compensation. At the end of the day, it's your decision -- you can take that as a withdrawal or reinvest in the business, but the only way to build an agency of value is to be creating tangible business value each year.
Running Your Agency Profitably
If you haven't yet achieved the AGI 55-25-20 Ratio, here's the action plan to help you get started:
- Measure where you are right now. Go back and look at the books. Make sure you're measuring this and reporting on this every month from here on out.
- Set your goals and timeline, then identify the biggest problem areas. Start there and work towards your goal.
- Talk to others for help. I can't emphasize this enough. Need help with sales, client servicing, finance, or another area? Tap into your network or get in touch with us -- get help from people who've been there before and can help you head in the right direction.
What challenges has your agency faced on the road to profitability?