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The Problem Most Agencies Don’t Realize They Have
Understanding agency profitability is one of the most important and most overlooked aspects of running a successful creative or marketing firm. If you have operated an agency for any length of time, you already know that not all revenue is profitable. This becomes obvious once you are juggling a large number of projects. Some projects consume a disproportionate amount of time, others take very little, and yet your net income still doesn’t reflect the work you’re putting in. Agencies that can’t accurately identify the profitability of each project or client relationship will struggle to understand which work is driving profit and which work is quietly eroding it.
Why Profitability Begins With Client and ProjectProfitability Analysis
The solution begins with tracking time consistently and reporting on project and client profitability. Smaller to midsize agencies tend to benefit the most from implementing a structured profitability analysis because it gives them a clear picture of which clients are worth scaling and which ones may be harming the business financially. The entire process starts with building a fully loaded cost rate. To determine this, you must allocate overhead across your employees, and the simplest and most logical starting point is either base salary or total compensation. Using total compensation is often the cleaner option because it reflects the true investment the business is making in each employee.
How to Build a Fully Loaded Cost Rate
The first step is to gather all employee salaries. The second step is to estimate the number of direct or client hours you expect each employee to work in a year. After that, list all overhead expenses such as rent, insurance, software subscriptions, and any other monthly operational costs. These costs should be allocated proportionately, with higher salaried employees receiving a larger share of overhead and lower salaried employees receiving a smaller share. This process produces a fully loaded cost for each team member.
Understanding Expected Client Hours
Next comes determining expected client hours. There are 2,080 available work hours in a working year, based on a 40-hour workweek and 52 weeks. From that number, you subtract vacation, sick leave, training, administrative tasks, internal meetings, and other non-client activities.Across agencies and other professional services firms, the industry standard for a fully client facing employee is typically 1,800 client hours per year.This is considered the baseline expectation for roles dedicated to client delivery.Senior leaders or strategic roles will fall below this number, but for day-to-day client facing positions, 1,800 hours is considered the benchmark.
How to Calculate Hourly Cost Rate
Once you have both fully loaded cost and expected client hours, you divide one by the other to determine the hourly cost rate for each employee. This is not a billable rate. It is a cost rate, representing what it costs the agency for that employee to work one hour. With that clarity, if an employee spends an hour on Project A, you know precisely what that hour costs.You also know that you must charge clients more than that amount to maintain margin.
The Pitfall of Undercounting Client Hours
A frequent pitfall occurs when agencies underestimate client hours by classifying too much time as internal rather than client related. For example, some agencies hold weekly meetings to discuss every active client and assume that time is not client specific. However, reducing expected client hours increases cost rates. At a certain point, your cost rate becomes artificially inflated, which results in pricing that may look too high to clients and prospects even though your workload has not changed. The issue is the math, not the work.
Why Time Tracking Is Non-Negotiable
Once cost rates are set, the next essential component is tracking employee time. Many agencies position themselves as modern or disruptive by saying they do not bill hourly. That is completely acceptable.Billing hourly and tracking time are unrelated concepts. Tracking time is about accountability, clarity, and resource allocation. If you ran a manufacturing company, you would know the cost of every widget in your warehouse. If you ran a car dealership, you would know exactly how many units you had on the lot. Inan agency, hours are your inventory. If you do not track your inventory, you cannot run a profitable business.
Using Cost Rate and Time Data to Evaluate Profitability
After you have reliable time data, you can begin evaluating profitability. For example, if Bob and Sue work on Project A, and Bob's cost rate is 150 dollars per hour and Sue's is 225 dollars per hour, you simply multiply their hours by their respective cost rates to see the total cost of delivering that project. From there, you can compare delivery cost against revenue and determine whether the project was profitable.
What to Do When a Client or Project Is Not Profitable
If a project or client turns out to be unprofitable, the next step is analysis. Did you estimate incorrectly? Did you scope the client relationship too loosely? Did the client add additional deliverables that were never formally included? Did the work take longer than anticipated? Once you understand why profitability was off, you can decide whether to restaff the project, reallocate resources moving forward, tighten your scoping process, or reprice the relationship entirely. Sometimes it is not about fixing the current engagement but about learning what needs to change for the next one. Over time, historical data combined with real cost information helps you anticipate the true effort required for future work.
Do Not Forget Contingency Hours
Many agencies also overlook contingency. Anyone building a house budgets extra time and money for unpredictable issues. Agencies should do the same. If you estimate a project will take 500 hours, you should add 50hours of contingency. These CYA hours protect your margin and are a normal part of responsible project planning. If you’re not doing this today, start now.
How Profitability Tracking Transforms an Agency
We see the impact of this work with clients every day.Agencies come to us with their P&L statements, trying to understand where they are making money and where they are losing it. Once they implement profitability tracking by client or by project, they gain immediate clarity.They can see which projects they should avoid in the future, which clients require repricing, and where resources should be reallocated within the agency.In every case, the insights are transformative and lead to stronger, more predictable margins.
If you want to learn more about implementing client and project profitability analysis in your agency or want help building these calculations for your team, reach out and we can walk through it together.
