The Basics, Profit = Revenue - Cost

Basic, quick equation for figuring out costs.

Profit = Revenue - Cost

Profit is calculated by taking your billable hourly rate multiplied by how many hours work and subtracting your fixed overhead costs plus your cost per hour for an individual.

P = Profit
R = Revenue (in this case your actual billable hourly rate)
C = Fixed cost (your overhead) + Hourly Cost (hourly amount it is costing you for the individual)
And let x = # of hours worked

So to figure out how much profit you would make on an individual that you bill @ $200 an hour, but costs you $100 an hour and has a fixed overhead cost (i.e. annual portion of rent, equipment, utilities, etc) for the individual of $25,000, the equation would be;

P = 200(x) - 100(x) - 25,000

Your profit would on the individual would then equal $100 an hour multiplied by how many hours worked, subtracted by your fixed costs.

Thus if the person worked 1600 hours;

P = 200(1600) - 100(1600) - 25,000

P = 320,000 - 160,000 - 25,000

Total profit = $135,000.

Flip through the site for more articles and charts for calculating hourly rates.

FTE Charts

I have added two new charts to the Agency Forms Section of this site. These charts illustrate how a typical advertising agency figures out budgets for yearly client fee compensation. These charts are generic and should be used as a simple guide only. All agencies have their own unique formulas for figuring out agency compensation and its a great idea to build your own model. In today's agency world, the FTE model is being used less and less as agencies develop their own unique compensation plans.

Lastly, as with all important financial decisions, utilize your accountant, these forms are for illustration purposes only. To learn more about these charts, visit the accounting section of this site for additional articles.

Simple FTE Chart Utilizing Blended Rates

FTE Chart Utilizing Individual Salaries for Staffing

Agency Basics - Calculating the Agency Fee by using FTE's

This article is one in a series of articles on Agency Accounting that can be found in the Accounting Section of the Library on this site.

Agency compensation is based on a formula that in general tries to cover the amount of time the agency is going to spend on the client’s business. Although the agency may get commission on media or production purchasing, or even additional income from the creative services area, the fee is the main form of agency compensation.

In earlier articles I mentioned how the agency might figure out it’s hourly rate and the amount of chargeable hours an employee is billable. This rate multiplied by the hours is equivalent to one agency FTE billable cost. (Keep in mind that the FTE doesn’t mean you are locked into a dedicated staff member, the FTE is used as a time equivalent.)

Here are some examples of fee arrangements that vary hourly rates and overall billable hours per FTE. In some cases, it may be better to lower or raise your rate depending on the amount of hours you think will be billable to the client.

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Agency Basics: Setting Hourly Rates

In the past, traditional agency management felt that their compensation for their company would be higher if they convinced their clients to hire them on a fee basis.

Recently their has been a trend towards alternative agency/client compensation. However, in most cases, agency’s will still use a fee system that is comprised of an estimated cost that calculates X amount of hours at an hourly rate of Y. Although an agency fee might be comprised of multiple hourly rates for individual staff members, one way to reduce, or discount the hourly rate, is to take the average hourly cost for the staff (or what is often referred to as a “blended” rate) and apply that cost to all of the estimated time. Although the blended rate is often used, the agency will still set out to determine the individual rates for each staff member.

Agencies will often not have the same internal calculated rates, since each business will have it’s own unique overhead and salary costs that would apply to only that company. However, agencies centered in certain geographical locations may have rates that are comparable.

This standard for configuring agency/client fee agreements is often based on the number of FTE’s assigned to the client’s account. One FTE stands for “fulltime employee equivalent.”

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Agency Basics, Alternate Forms of Compensation

In many cases additional forms of compensation will be made to the agency that is on top of the agency fee. This compensation may be in the form of commissions on production or media purchases, charges for the agency’s creative services department or other forms of agency charges.

Commission

Dramatic changes in agency compensation have occurred over the years, “According to the 2004 ANA Agency Compensation survey, a mere 10% of the 112 major advertisers surveyed said they still pay commissions, down from 21% in 2000. Nearly three quarters (74%) rely on either fixed/hourly fees or a blended compensation model that includes fees and commissions (8%).” (Source ANA Press Release)

However, in the past, agencies have traditional been able to charge a commission on out-of-pocket client costs in relation to media or production (print) purchasing. Although there has been a trend away from charging commission, agencies will strive to do what is financially in the best interest of themselves and their clients. Some agencies increase their rates to compensate for the loss of
commission, where some agencies have gone completely away from charging them.

In the past the traditional rate of commission on print or production related purchasing was .17625% and varies from 0% to 20%. Production commission is traditional charged on outside
vendor bills for items such as scans, art purchases, color house work, printing and manufacturing.
Media commission has also varied from 0%, 3%, 5%, and up to 15%. Media commission is traditional charged on purchasing advertising space in print, out-of-home, broadcast and other mediums.

Services not normally included in the fee.

Fee agreements should be very specific about what types of services the agency will provide, and additional services not provided in the fee will then be estimated and billed to the client on a project by project basis. This may be typical of clients who originally asked for traditional ad campaigns, but not internet related work or perhaps PR or research related projects.

Creative Services (Production & Studio Services compensation)

Traditionally, agency fee compensation included all staff members related to the clients work minus the production studio. In some agencies, sperate production estimates will be created for the client to include hourly or flat rate charges for studio mechanicals, proofreading, color copies, final file creation, final file releases, discs, programming and more. And in a few circumstances, the production estimates may include production management and traffic or project management.

Trends
There has also been a trend for agencies to bring traditional color house related work inhouse. This enables the agency to charge for color house related items that it would have normally passed through as out-of-pocket costs. These production services may include high resolution scans, retouching, proofs and final file creation and releasing.

To read more about trends in agency compensation, read the new 2004 ANA Compensation report, available at the ANA bookstore at: www.ana.net

The AAAA also has a variety of agency compensation related publications available at www.aaaa.org