Fixing the bottom line By Betsy Sharke

While the politicians debate whether the recession has truly ended and pundits cross swords over President Clinton's economic package, one fact remains beyond dispute: In the

“We’re finding the cash crunch has had a major impact on the advertising agencies,” notes Rick Gould of New York-based Gould & Co. Even if agencies are profitable and their financial statements show a decent year, everybody seems to be broke. We’re trying to coach our clients on how to squeeze the most out of the bottom line.”
Gould should know. His CPA firm and financial consulting group counts several advertising agencies and PR shops among its clients, including Grey Advertising, Young & Rubicam, Ogilvy & Mather, Georgeson & Co. and Burson-Marsteller. Gould is currently at work on a book, Madison Avenue Management, that he says “comprises a detailed overview of the practical aspects of managing for profits.” Here he presents eight tips for agency executives to get onto–and stay-on the plus side of the ledger.
Find a friendly banker who understands the advertising agency business. An agency’s line of credit can disappear overnight, as one mid-sized agency advised by Gould found out. The shop was making respectable profits–net income of $1 million on revenues of $5 million, for a healthy 20% margin. The owners decided to give bonuses to staff, including themselves, that totaled $1.3 million, to reap tax benefits and to reward top performers. As a result, the financial statement showed a loss of $300,000. Although the owners were prepared to lend back to the company if needed, the bank panicked and revoked the agency’s existing $500,000 unsecured line of credit. The only way the bank would reissue the line of credit was if the agency put up matching funds. In the end, the agency switched banks and decided to limit its compensation.
The problem, in part, is that so few banks understand the advertising agency business and too few agencies understand the politics of banking. Find out if any banks in your area have targeted advertising agencies as customers they want. Chemical Bank in New York and the Bank of Boston, for example, have loan officers who specialize in agency lending. In some markets, however, there are no friendly banks, and agencies have to look outside the state. In Texas, most agency relationships dissolved when the local banks went belly up and outsiders acquired them.
Bankers don’t like surprises, so an agency’s financial statements should carry as much detail as possible and leave little to the imagination. Direct costs, for instance, should be itemized so the bank can see precisely what they are. If your agency is running in the red, consider adjusting owner or top executive salaries to strengthen the balance sheet.
Review your internal financial systems–sometimes you can turn a loss into a profit center. One Madison Avenue agency found its rebillables (messenger services, printing, production expenses, etc.) were costing it money. The agency wasn’t even recouping the administrative costs. By making a number of strategic adjustments, rebillables became a profit center. First, the agency added a 20% markup on most items (the minimum markup an agency should settle for is 17.65%). Next, the agency identified the rebillable categories that were consuming the most money. Printing was among the highest: The agency was spending $300,000 a year on outside print shops. By bringing printing in-house, financing the equipment and keeping the charges to clients at the same level, the agency increased its net profit by $100,000 a year. That money was enough to hire one additional vice president.
And if your computer isn’t giving you a line-by-line analysis of what’s going on, chances are you’re losing money. One small agency spent $50,000 on a system that gave it virtually none of the information it needed. The agency actually saved money by dumping it and starting from scratch.
Love your clients–but not too much. In order to keep clients happy in tough times, many agencies have tried the value-added approach, piling on additional services like marketing consulting duties, without increasing their fee to the client. This strategy has particularly hurt agencies that rely on fee-based accounts for revenue. But even large agencies that combine a fee and commission payment system have watched as once-profitable clients have become an economic drain. To get to the bottom line on each client, analyze the time actually spent servicing the account, particularly the creative department, against the fee or retainer you’re being paid.
One major New York agency found its biggest client was making money for the agency in some areas. But when it came to projects where the agency functioned as a consultant to the client, the agency was losing money. In this case, the agency was able to switch from a fiat fee arrangement to a charge tied to actual time spent. If the client won’t switch completely to a time-based arrangement for consulting activities, consider renegotiating the contract to accommodate special or rush projects, billing for excess hours. For this type of analysis, a time management system is critical. It should not only track hours spent by department and person on each project for each client, but crunch the numbers to give you a range of profitability statistics.
Finally, if a client is still costing you money, end the relationship. You’re better off with fewer clients, less staff and a profit, than with more clients and a money-losing firm. In the ’90s, no agency can afford to carry a client. If it’s a new client, after six months you should be able to assess whether it will be profitable.
Pay attention to key ratios. It’s not enough to be profitable; an agency can’t afford to be cash poor. A healthy agency should have a liquidity ratio of 2-to-1, which translates into the ability to have twice what is needed to cover current debt, payroll and general overhead. Consulting beyond the normal client relationship should be billed at 3.5 times labor cost. One of the key ratios in advertising is time-to-labor cost; accept a 3-to-1 ratio at a minimum. To get a true time-to-labor ratio, strip away ancillary costs like secretaries’ time. If an account is generating $300,000, your main labor sources on the account–creative and account management-should not be costing you more than $100,000.
Because you are running an agency, not a bank, receivables should be followed up after 30 days. Clients should be told your cash flow is as tight as theirs. It has become politically as well as economically correct to be direct and aggressive about collecting outstanding bills. If receivables, particularly larger media bills, go unpaid for 60 days or more, they can put an agency in the danger zone. Additionally, banks will monitor receivables, and too loose a collection policy could put your credit line in jeopardy.
For some hefty out-of-pocket expenses, such as commercial production costs, consider negotiating with clients for an upfront or partial payment. For example, if a commercial is going to cost $500,000 to produce, consider getting $250,000 in advance to handle some of the immediate costs, with the rest due on the typical payment schedule.
Consider bonuses instead of raises for key people.
It may be more important during lean times to remember the old advertising saw that an agency’s assets go down in the elevator each night. Identify the people in the agency who are making a difference–those members of the staff who are not easily replaceable because of talent, expertise or contacts–and make it your business to keep them. Keep the list short. Then consider a bonus plan in lieu of raises. That gives a short-term reward to those who are crucial for the agency’s long-term success. At the same time, it doesn’t lock you into a higher salary that you’ll be faced with increasing the following year even if your cash bind continues. If necessary, the agency owners should cut their own compensation to ensure these critical employees are rewarded.
Assess your state sales tax liability. If you don’t know what it is, find out. An audit can put an agency out of business. One New York agency watched an audit of its past three years of business turn into a nightmare. The state was particularly interested in the agency’s policies for charging sales tax on art work, mechanicals, typography, design and printing. The state used a three-month period as a sample, reviewing every invoice. Auditors found the agency had not applied some of the tax rules correctly, and 14% in additional taxes were due. And not just for the three-month sample period, but for the entire three-year period under audit. While sales taxes are costs that should be paid by the client, in this case, some of the clients had long since left the agency while the agency retained the tax liability. In the end, the agency swallowed the tax bill, which came to $20,000.
Gould has seen cases where additional tax assessments have gone as high as $200,000 and beyond. If an agency has been filing incorrectly, state auditors will go back several years to calculate assessments. Says Gould, “The cost to the agency is substantial, because most agencies will have been making the mistake year after year.”
Renegotiate your office lease. If your rent is more than 15% of revenues, you’re spending too much. In most cities, it’s a buyer’s market when it comes to office space, and buildings would rather renegotiate than lose a tenant. Treat the renegotiation process as you would a new lease. Ask for one month of free rent for every year of the lease, so a five-year renegotiated lease should net you five months of free rent. Many agencies signed leases in the mid-to-late ’80s when the market was hot and are paying nearly twice what they should be. In New York, for example, some agencies that leased several years ago are paying $50 to $60 per square foot, while the current rate is about $30. Check the terms of the “escalation clause,” the cost of building management which may be adjusted yearly. It is a fee that is often miscalculated. Make sure the lease has a penalty-free escape clause that would be activated if you move to other space within the same building or to another property managed by the same firm. That allows you to lease only the space you need and adjust with a minimum outlay if your business expands or contracts significantly.
Small to mid-sized agencies should never sign a lease that makes the owners personally liable for the lease. If the agency goes out of business or defaults on the lease, the personal assets of the owners or partners are then at risk.
Have both a business and financial plan–a minimum of five years out. By blending both, an agency is able to put hard numbers against its goals. Beyond describing these goals in realistic terms so that them is a clear path between Point A and Point B, a business and financial plan can help an agency weather unexpected downturns. One agency got its 90-day notice from a client it had had for 20 years. Not uncommon, but the firing was unexpected. Because the agency had a financial plan in place, it knew it had 90 days to generate $250,000 more in fees or commissions. The agency had little cash reserves, profits were tied up in receivables, the credit line had been maxed out and the owners could only cover the costs for six months. The solution was in %he financial plan, which had targeted the acquisition of a specialty agency the following year. The smaller agency was profitable and liquid. Acquisition talks were stepped up and the deal was sweetened, but because of the cash bind, the payout period was extended. The additional billings gained from the acquisition covered the shortfall.
Without a business and financial plan, few agencies facing a $250,000 monthly shortfall would have considered an acquisition. But this agency already knew what the deal would cost versus what it would bring in. It gave the agency options and the flexibility to move quickly.
Copyright Adweek L.P. (1993)