The Essential Finance Rituals for Scaling Your Agency

Running an agency can be a challenging task, and the success of your agency depended on many factors. One of the most important things you can do to scale your agency is to have a strong financial foundation.  In this article, I will guide you through a step-by-step process to assess how well your income statement is set up and what necessary steps you can undertake to strengthen it for better insights.

The income statement is a vital document that provides ongoing insights into your financial performance. It not only reveals the growth of your revenue but also indicates your profitability. A well-structured income statement allows you to address crucial questions consistently. To assess your financials effectively, I recommend starting with a thorough examination of your income statement. Access the reporting section of your accounting software and generate a profit and loss (income statement) report. This will provide you with valuable information for your financial evaluation.

Revenue: Once you've generated this report, you should begin by analyzing your revenue. The first thing you want to do is make sure there is no pass-through revenue, such as media, included in this area. If you have $5 million in fees and $15 million in pass-through revenue, make sure to move this pass-through revenue into "other income." This way, when you're looking at this report, you will instantly know your actual revenue.

The second thing you will want to do is determine if you have your revenue broken out by line of business. Oftentimes, when I look at individuals' finances, I see just one line for revenue that reads "sales." By breaking it out by line of business, you can understand what percentage of your revenue is generated by each line of business, and which area is growing. This analysis will help you focus on areas where you need improvement to achieve better growth.

Cost of Goods Sold: Once you're done with analyzing your revenue, the next step is to analyze your cost of goods sold (COGS). Your COGS must reflect the total cost you spend on executing client work, including payroll, freelancers, technology, travel & entertainment, and any other expenses incurred for clients. This is a crucial step to identify which areas are creating a strain on your finances, and you can take necessary measures to reduce your expenses in these areas to boost profitability.  Oftentimes I will see $0 in Cost of Goods sold, or I will not see any employees in this area.  This is an instant red flag that this is not properly done.  Additionally, if there is any pass-through cost such as media, you will want to move this to "Other Expenses" so that when you look at your Cost of Goods Sold you know that it properly reflects the cost of doing your client work.

Gross Profit (Margin): Your gross profit is the difference between your revenue and the cost of goods sold. In this assessment, it is crucial to ensure the accuracy of this figure. If it matches your revenue, it indicates an error in calculating the cost of goods sold. Typically, the gross margin falls within the range of 35% to 60% of your revenue. While you aim for a 50% gross margin, the primary focus of this exercise is to verify its accuracy. If you observe a gross margin of 10% or 90% of your revenue, it is likely that an error occurred in either your revenue or cost of goods sold.

Expenses (SG&A):  The next area you want to analyze are all of your expenses that are not related to doing client work.  My experience is that this tends to be a long laundry list of expenses that is not nicely organized.  I recommend that all of your expenses are categorized in either sales & marketing, operations & finance or executive.  By having everything in one of these three buckets you can quickly assess what percent you are spending in this area.  So for the self-assessment you will want to determine how nicely categorized are your expenses so that you quickly see how much you are spending in each area.

Other Income & Expenses: Any ancillary revenue or expenses should be moved to this area.  So you will want to make sure that if there is revenue or expenses that are not core to your business they are moved to this area.  This includes as mentioned above your pass-through revenue and expenses.  Additionally, any debt interest, depreciation or amortization should go into this area.

Ensuring a strong financial foundation is crucial for the growth and success of your agency. By following this step-by-step assessment process of your income statement, you can evaluate the effectiveness of your current financial setup and identify areas where improvements are necessary. It's essential to focus on your revenue, COGS, operating expenses, and cash flow to keep your finances healthy and drive the profitability of your agency. So, take your time, assess your financial situation regularly, and make necessary changes to establish a healthier financial foundation that will support your agency's growth and success for years to come.