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Chip and Gini discuss the basic financial reporting that every agency owner should have ready access to and systematically review on at least a monthly basis.
Knowing the numbers may not be the most exciting part of being an agency owner, but it is essential to understanding the business and positioning it for profitable growth.
In this episode, the hosts explain various financial terms and why specific reports may be useful. They also describe what to look for when reviewing these documents.
Resources
Quotes
- Gini: “I will admit that when I started my business, and people were talking about P&Ls, I had no idea what they meant. I’ll admit that.”
- Chip: “If you’re in business long enough, as an agency owner, you’re effectively getting an on the job MBA.”
- Gini, on creatively getting around big companies’ payment policies: “Some of the pushback I get from other agency owners is well, I work with big companies such and such, and they won’t work that way. That’s baloney.”
- Chip, on the importance of getting started using accounting tools: “…a lot of agencies do not have their houses in order with these reports. The important thing is to start getting at least the basics correct. And then you can bite off more and perfect it.”
Transcript
CHIP: Hello, and welcome to another episode of the Agency Leadership Podcast. I’m Chip Griffin,
GINI: and I’m Gini Dietrich.
CHIP: And we’re here today to talk about P&Ls. What is a P&L, Gini, this is one of those terms just gets thrown around a lot.
GINI: I will admit that when I started my business, and people were talking about P&Ls, I had no idea what they meant. I’ll admit that.
CHIP: And it’s, you know, we all have that point, because nobody knows the term until they get it defined for the first time. We’re not born with this knowledge. And very few agency owners come with the business knowledge to know what these things are.
GINI: If you have an MBA, you definitely know, but most of us agency owners do not have MBAs.
CHIP: No, in fact, I, I can think of very, very few agency owners who have MBAs or anything even close to it. But if you’re in business long enough, as an agency owner, you’re effectively getting an on the job MBA. And one of the things you learn about are financial documents like P&L, but the P&L is something that you as an agency owner, you should be using all the time to assess your business.
GINI: Right. So you ask the question in the agency owner channel in Slack, which I thought was really interesting to see different perspectives, but most people, I would say, said that they have it either through FreshBooks or QuickBooks that their accountant updates for them every so often, and they don’t really use it to run their businesses. I think that was the mass majority. Right?
CHIP: Yeah, that seemed to be the consensus, obviously, it was not a scientific study, right. But there didn’t seem to be many folks chiming in and saying, Yes, I look at this on a monthly basis, or even a quarterly basis to, to really look for trends and figure out what’s working and what isn’t. But I would argue that is the wrong approach, you need to, you know, be completely familiar with your P&L, you know, you shouldn’t be looking at it on a weekly basis, certainly in agency business, but you should be looking at it monthly, both to ensure its accuracy, and also to spot anything that perhaps you’re not sensing anecdotally in your running of the business.
GINI: And not only that, but you then can look at I mean, as part of that accounts receivable, and you know, what clients haven’t paid on time, or you know, where you are from a net payment perspective and all that. I would actually say it’s almost impossible to run your business without having it. Now, I say that, of course, people run their agencies without doing that. But there was a year not so long ago that I didn’t run my business with that, because I was just so – it was a rough year, and everything came off the rails. And it was because I was not paying any attention to the financial piece of it at all.
CHIP: Right, and we’re sort of using P&L here as shorthand, there’s an actual P&L or profit and loss statement for your business. But it’s it as you’ve sort of alluded to, I use it as a shorthand for the whole package. So it’s a P&L. It’s it’s your accounts receivable, accounts payable balance sheet type things, it’s the basic package of reports that QuickBooks or any other simple small business accounting package can spit out quite easily, and will help you to see things before they become real major issues. And unfortunately, a lot of agency owners, particularly smaller agencies, although frankly, I’ve been surprised by some, you know, starting to become mid sized agencies that run themselves mostly by looking at their checking account and saying, is there money there? Yes. Okay. Cool. Things are going well. That is not a good way to run your business.
GINI: No that’s a terrible way to run your business. But I think we’ve – I certainly have been guilty of that. So it’s not I think that’s fairly typical. You know, I have Okay, I have $60,000 in the bank. Sure. I can make this higher? Hmm. Don’t do it that way.
CHIP: No, no, because there are all sorts of reasons why you might have that money in the bank, perhaps you have a client who has just gotten caught up on back payments, or you’ve got someone who paid particularly quickly or, you know, so there’s all sorts of reasons why you might be flush with cash. At the same time, you know, you might, you might find yourself in a position two months later, where you haven’t billed enough to keep that cash flow running. And so you need to eat into that reserve in order to pay basic bills. So a terrible, terrible way to run a business.
GINI: And we have clients who at the end of the year, like to prepay for services for the following year. And so you know, in January, you get this huge lump sum of money. And January always looks amazing. But you have to settle it out for the rest of the year, so that by June, you’re not out of money. You could very well look at your bank account and go, Oh, my gosh, I have $400,000 sitting here, I can do this and this and this, well, no, you still have to pay for the rest of the year based on that.
CHIP: Right. In fact, in in the past in some of my agency businesses, I’ve had a few particular clients who were you know, would always dump money out at the end of the year, but then they wouldn’t pay again until March or April. And so, you know, so you not only have a particular spike in January, but then that eats up what will come normally later. So it’s it can get really ugly really fast. If you’re playing, you know, off of just a checking account statement, you really need to be looking at the P&L and why don’t we talk about the for the standard profit and loss statement. What does that actually show? What are the basics that that a profit and loss statement tells you, other than your profit and loss, I suppose.
GINI: Yeah, so I always like to look at my income versus my net profit. But I also keep track of – and I have it open right now, because I pay attention, I actually pay attention to it every day, because we have lots of credit card payments that come in pretty consistently. So I do look at it every day. But so I look at income, I look at cost of goods sold, gross profit expenses, cash flow, and then net profit.
CHIP: Right. So at a high level, the the key things that you need to be checking what the P&L tells you are money out and money in. So revenue or income, depending on whatever program you’re using, they’ll sometimes use those terms interchangeably. Some programs will call it sales, doesn’t really matter what it is, it means money coming in the door. And then on the expense side, money going out the door, and pretty much all of them called expenses. And so you start there, and you get those numbers right in the aggregate, but then you break them down into categories. And on the revenue side, it’s important to understand the different kinds of revenue streams that you have. So in your particular business, obviously, you’ve got very different kinds of things that you’re selling, you want to make sure that your accounting for that. A standard agency might just have project revenue, retainer revenue. But agencies even on the PR side, increasingly do some degree of advertising on behalf of their clients, you should have that as a separate line item, because that tends to be more of a pass through. So you know, if you’re, if you’re incurring the expense for Google AdWords on behalf of your client, and you’re just passing it through your market, you want to have that as a separate line item, because otherwise it will inflate how much it looks like you’re actually generating as revenue for an agency as opposed to just serving as the payment agent for that account.
GINI: Right. Travel and expenses, I would say the same especially if a client is reimbursing you for that. I would say any reimbursables.
CHIP: Any reimburseables. Yeah, yeah, absolutely. Because you certainly need to be tracking it. But you also need to understand that that’s, you know, that’s not really a sale, that’s something that you’re just going to end up getting reimbursed for at the end of the day. On the expense side, you want to make sure that you’re breaking things out into very clear areas, so that you can see what the trends are. So, you know, at a basic level, you have salaries and benefits typically grouped together, you would have travel as a grouping, you would have training and education, those kinds of things, you would have office expenses, you know, you would have various kinds of insurance. Most of these packages come with a pretty good basic set of categories and accounts that you can use. But you should also make adjustments based on the specifics of your agency to make sure that you’re really able to zero in on, you know what expenses you have, and what trends may be popping up. So if you’re looking at a P&L, and I would encourage you through the course of the year, you want to look at a P&L where you’ve got monthly detail, so January, February, March, etc. And you can see all of a sudden, hey, I’ve got a spike in March on this, why? and dig into it, figure it out, maybe there’s a perfectly reasonable explanation, maybe it’s something got miscategorized, maybe someone on your team incurred an expense that you you know, when you signed off on the expense report, but you didn’t really think about it at the time, there’s all sorts of things that you can spot very quickly on those. And you can also spot trends. So if you see revenue or expense accounts changing consistently, month over month, okay, that tells you something about your business that maybe you didn’t spot just through the conversations you’re having with your team members.
GINI: Right. And I also find that the P&L is is a little bit challenging from the perspective of its historical because all the information is is entered as it – either as it happens, or at the end of the month. And so I always like to keep a cash flow projection. I keep it in a spreadsheet, just because I have not been able to find software that does it accurately for me. So I keep it updated. And I just export – it used to be from QuickBooks, now we’re using Bunch, but I just explored the P&L from that. So that I have actually like right now I have actuals through June and then July through December, I have projections. So I have projections based on client revenue, based on what we think we’re going to do on the Spin Sucks side, goal wise. And then I have of course, my expenses and cost of goods sold projected out as well, some of that’s pretty easy, because it’s the same cost, like insurance is the same cost every month. So I’m able to project that out. But then it shows me Okay, what how accurate was I for the for the previous month? And what what else am I missing? That I need to have so that I can project Okay, if we do X, Y and Z from an income perspective, I know I can provide raises by this time of the year. So it helps me figure all of those pieces of it out too.
CHIP: And one of the things that we saw in the responses in the Spin Sucks community on this was the several people are using Excel spreadsheets, in addition to whatever package they have, for various reasons, you’re using it for cash flow projections, someone else indicated that they use it in order to take a look at the total cost because and this is something that trips up frankly, a lot of agents, small agency owners, that the agency owner’s compensation often doesn’t show up in the actual P&L that the software generates. And it all comes down to as we’ve talked about on previous episodes, you need to talk with your accountant about how you should be paid by the business, get their advice, a lot of agency owners are taking a draw or they’re taking money, sort of after the P&L that’s how they compensate themselves. But that’s not a good way of running the business. It’s, it may be good for tax purposes. So I’m not telling you don’t do that you don’t necessarily want to make yourself a W2 employee of your own agency. But if you’re not a W2, then it’s not going to show up in most of these packages as an expense. And so you then need to calculate that in because when we talk about how agencies should be having at least a 20% profit margin or things like that, that includes basic compensation for the owner. And so if you if you need to add that back in for your own tracking purposes, you may need to use a spreadsheet or something like that in order to to true it up, if you will, from a management perspective and get it right.
GINI: And, if you don’t have if you’re not a W2 employee, and you just take a distribution, you have to pay taxes on that distribution. So you can’t you can’t just be like, Oh, well, I have extra money, but you haven’t actually paid the taxes on the distribution that you’ve taken.
CHIP: Correct. And there are…as you work with your account, you will find that there are all sorts of pros and cons to how you take it out. And so a lot of agency owners will actually do a mix where they’ll take something through W2 and they’ll do some through through a draw. And so you really need to look at your own particular circumstances. But when you’re looking at a P&L from a management perspective of your business, you absolutely need to be calculating in your own compensation. And it should be fair compensation. So if you were hiring someone similar to you, what would that compensation be? So and the mistake a lot of agency owners make when they look at their P&L is they’re like, Oh, you know, I’ve got a 42% profit margin. Well, but there’s no comp for you in there. So you know, and once you put your own comp in there, particularly for a small agency, your profit margin, maybe down, you know, more like 10 or 12%. And at that point, that’s a very different story. So understand what you’re tracking in that P&L.
GINI: Yeah. And I think it definitely depends on you know, what’s important to you and to your point, what your accountant recommends, and all those kinds of things. But definitely, you definitely have to pay attention to that. And I mean, that’s another thing I learned in my own business running MBA, which was very expensive by the way, I didn’t account for the distribution that I was taking. And I was shocked at the tax bill that I received. Had I had that in my spreadsheet, which I do now, that becomes less shocking, because you know exactly what you have to pay.
CHIP: Absolutely. And and there are other things that go into how you’re putting this document together, they’re important to think about. The biggest one that trips up people, in addition to their own compensation is the idea of doing cash versus accrual accounting. And again, this is something you want to work with your accountant on. From a management perspective, accrual accounting, will give you the truest vision of how the business is working. But most, or many agencies are going to end up paying taxes on a cash basis. So often, you need to keep effectively two sets of books although if you’re doing it by accrual, it’s pretty easy to generate the cash, it’s the other way around is much more challenging. So if you have to pick from a place to get started and you want to shortcut it, start with the accrual, it takes more to put the data in, because you know, the real difference is cash is basically when the money comes in, and when the money goes out. So often that works better for tax purposes. But if someone’s pre paying or paying late, it can really distort what months look like, or years even accrual is you’re effectively what’s called booking revenue and booking expenses for when they actually take place. So if I’m doing work for you, Gini, in March, I will record it from an accrual standpoint as March regardless of when you pay me. Whereas cash, no, when you pay me in August for that March work that may be when I see it.
GINI: Right. Right. Yeah.
CHIP: Not that you would pay that late, I was just giving you a hard time.
GINI: Or you know, next April, I might take even longer.
CHIP: Well, then that’s honestly, that’s particularly if you’re dealing with smaller businesses, as your clients as an agency, those are things to think about when you’re doing cash forecasting, right? Because you may get that bump at the end of the year as they’re thinking about taxes and how to minimize them. But you also may get slow payments in April when they sit there and they realize they didn’t account for their own tax bill. And so now their own accounts are depleted. And so they may start getting a little bit slower in paying, which which naturally leads to the other document that’s part of this, what I would call P&L package, which is your accounts receivable or your aging report, or they call them different things in different packages. But basically, you want to know how much revenue you have outstanding, what do you have for invoices out there that have been unpaid? You know, how many of those are in the zero to 30, 31 to 60, etc. And that’s days after it was due. So those are the kinds of things that will help you figure out, are we having a lot of slow payers? is that changing from what it was historically? and those can have real material impacts on most businesses.
GINI: Yeah, and you know, I, that’s one of the things I paid to paying attention to early on. And we were easily 30, 45, 60, sometimes even longer net, which, when you’re running a small business is extraordinarily hard. And so we implemented deposits. So you have to pay certain things upfront. And we also said, so now we pay now we, we used to invoice at the end of the month, and now we invoice previous, so right now we would be billing for August work instead of July. So you really think about those kinds of things. And some of the pushback I get from other agency owners is well, you know, I work with big companies such and such, and they won’t, they won’t work that way. That’s baloney. Because I’ve worked with company, I have worked with a Fortune 1 company. And as long as you set the expectation and understanding that you have to go through procurement and all that kind of stuff. But as long as you set the expectation that this is how you work, they’ll they’ll work within those confines, you may have to do things like we worked with a Fortune 10 company that we had to actually wait 90 days to get started because we required that deposit. So we got everything ready. And we got it all through procurement and got the PO and everything, invoiced them. And then when they paid, which was 90 days out, then we started the work. So we didn’t start the work 90 days in advance and then always have a 90 day net. So we did have that three months in there. That we didn’t do the work. But you know, the relationship was already built. And we were doing – that it wasn’t a problem. So there are ways that you can work around that kind of stuff to get paid when you should get paid versus trying to play bank for your clients.
CHIP: Right. And it is it is unfortunately, quite often the larger companies that try to play this game where they, they try to slow down payments as much as possible. And it’s now becoming trendy for some of the big companies to try to demand even 120 day or 180 day payment terms in some cases, which is absolutely nuts. And you’re absolutely right. A lot of times you can work with them to come up with something, either just by pushing back and saying no, we can’t agree to that. Or as you did come up with something creative and say, Okay, this is how we can work within your policies. But still make sure that we’re not fronting the cash. So work with your client contacts and with procurement or wherever else you have to at those clients and make sure you’re coming up with something workable. But regardless, you’re able to use these financial reports to figure out is something shifting in your business. And the more clients that you have, the more important these reports are, because it’s no longer just looking at the individual clients one by one, but it’s looking in aggregate, how is this impacting the business? And then what does that what does that mean for the future?
GINI: Yeah, and I think another thing that from an accounts payable perspective is you also want to be thinking about, okay, if I’m not being paid for 90 days, by an aggregate, then how does that affect the vendors that we pay? Now, certainly you can’t do you know, your lease and your phone and your utilities and things like that on in 90 day net. But there are if you know, if you have clients who are negotiating 90 day payment terms, then you negotiate 90 day payment payment terms with some of your vendors, too, because you can’t, can’t have the cash outlay. And that’s the kind of stuff that your reports will tell you, you can’t have the cash outlay before you receive it.
CHIP: Right. And these reports will also help you figure out you know, in our own personal lives, a lot of us will just you know, bill comes in, we write a check, we were done with it, or maybe we write checks once a week or every other week, you know, whatever, you just kind of, you know, send the money out the door. But when you’re running a business, you actually need to look at it strategically. And so you know, if you’ve got, you know, if your report showing you that you’ve got some slow payers and you know that this bill isn’t really due for three weeks, you know, don’t necessarily pay it in advance, make sure that you’re you’re managing your cash, but if you’re not looking at these reports, you’re going to have a hard time doing it. And that brings us to the other portion of this P&L package that I think is important, and probably the one that causes most people’s eyes to really glaze over. And that’s the balance sheet. And the balance sheet, if you generate a balance sheet report out of QuickBooks, as soon as you look at it, you will sit there and say what the heck because one of the things that can be very confusing to a lot of folks who haven’t owned their own business before, it deals with equity accounts for the owners, even if there’s a single owner, in most cases, and so it always ends up coming out to zero in the end. So there’s entries on that balance sheet that that don’t mean a whole lot to you because it doesn’t, who cares what your equity account is showing? Most cases except for tax, or if you ever sell the business, those things don’t matter. But what does matter is it shows your total assets and your total liabilities. And that’s something that’s really helpful, particularly if you’re doing an accrual report, you’re putting everything in on an accrual basis, you can sit there and see, okay, you know, if once everything comes in the door, and everything goes out the door that I know of, where do I stand? And so that balance sheet can be really helpful in understanding all of those things and help you to spot problems before they really become a disaster.
GINI: Yeah. And to – exactly to your point, the balance sheet does make your eyes glaze over a little bit where you’re like, oh, but it does take into effect, you know, what’s in your checking account, if you have savings, savings accounts, what’s in there. So it pulls all that together. So you can see it all in one spot, as well.
CHIP: Right. And I think you know, since since the feedback that we’ve gotten in and what I’ve seen in my own consulting businesses, a lot of agencies do not have their houses in order with these reports. The important thing is to start getting at least the basics correct. And then you can bite off more and you know, perfect it. So one of the things we saw in the comments was people talking about how they’re starting to integrate time tracking with whatever accounting package they’re using. And that’s very helpful, because that allows you to start looking at a project level, which we’ve talked about critical to running your business, you need to understand which projects are profitable and, and how to make them more so. But if you’re, if you’re not getting the basics, right, don’t worry about all those things, make sure you’re getting the basic ins and outs correct, then you start perfecting the categories, then you can start looking at how you tie in other bits of data into it. But one of the challenges I’ve seen a lot of agency owners have is that as soon as they realize, Oh, I should be doing all those things. In fact, as you’re listening to this podcast, you may be saying, oh, wow, I need to do all these things. But then it becomes overwhelming when you try to tackle it all at once. So don’t tackle it all at once, get the basics, start getting those building blocks in place and then perfect it over time.
GINI: Yeah, and it will take some time. And that’s okay. It’s totally okay, it takes some time you need somebody who I always say, Make friends with somebody in the accounting department, because you need somebody who’s willing to walk you through and teach you and help you understand it all. And you are getting a very expensive MBA as you’re doing this. But I find that it’s pretty satisfying to be able not only to understand it , but be able to use those reports to help you run the business and make really strategic decisions.
CHIP: Right, and it’s as your business changes, you’re going to need to make changes to this. So let’s say that you introduce an SEO practice, you’ll probably want to break that into a separate revenue line item. So you can track how is that performing. And so as you bring in different lines of business, or you you bring in someone who’s running a particular kind of program, you may want to split that out. And it’s it’s a balancing act, because you know, you never want to have a line item in your P&L that that’s accountable for just one client, for example, in most cases, not always, sometimes it is but you know, so it’s coming up with logical categories that help you manage the business better, because at the end of the day, these these P&L and other financial documents serve two purposes. One is to deal with taxation issues. And that’s what most people think of, but the real value is in managing your business more effectively. So make sure that you’re setting it up so that it actually is giving you the information that you need to make the right decisions,
GINI: Amen.
CHIP: And so now if you do not have proper P&L balance sheet, accounts receivable, all those things set up for your business. Absolutely end this podcast, listening, hit pause, go off, start thinking about how you do it. But start with the basics, get those right and then continue to improve from there and your business will run better and thank you for it.
GINI: And you’ll thank yourself as well because then you become very smart about it all.
CHIP: And you’ll be putting more money in your pocket hopefully, which hopefully, at the end of the day that makes a lot of agency owners really happy. So on that positive and profitable note, I’m Chip Griffin
GINI: and I’m Gini Dietrich
CHIP: And it depends.
