Agency Operations 101: The Right Way to Recognize Revenue

Hit the “update” button in Quickbooks online, sync your bank transactions, go to a P&L report and that’s how you report on monthly revenue as an agency, right?

Not quite.

Recognizing and recording revenue the right way - revenue aligned with service costs - is necessary for creating an effective agency operating model and understanding exactly how well your agency is doing financially.

First, agencies should forecast and recognize scheduled revenue rather than received revenue in their operating model. Scheduled revenue, sometimes also referred to as accrued revenue, is earnings from providing a service based on the period the services are rendered, regardless of when payment is received from the client. While you can report on an accrual basis in Quickbooks or other financial tools, this is often mapped to the month/day the invoice was sent rather than when the work was actually done, so typically, we recommend moving this data out of your financial tools and into a separate operating model.

This important distinction aligns revenue with service costs and operating expenses from the same period and makes it possible to calculate service delivery and operating profit margins accurately. Delivery margin minimums (50%+) and operating expenses as a percentage of revenue (20-30%) are core financial metrics that should be baked into agency growth plans and management policies. For more info on core financial targets, check out our post The Monthly Metrics You Need to Run Your Agency.

Another guideline for agencies is to forecast and record revenue actuals based on the net amount retained, for example, the amount billed to a customer less the amount paid to the ad network, subcontractor, etc. Revenue forecasts serve as a basis for creating budgets for service costs and operating expenses. Failing to subtract passthrough revenue distorts margins, inflating them to appear better than they actually are. Inflated profitability margins can lead to inflated budgets. In other words, recognizing retained revenue is necessary for using delivery margins and operating expenses as a percentage of revenue as meaningful health indicators for running your business.

While aligning retained revenue and costs schedules may seem very straightforward, it does require creating revenue schedules for project work and an efficient process for recognizing revenue based on service period rather than date of payment. If you are working off of hours that the client pre-paid for, record that revenue as it gets worked in your actuals and as an estimate in your forecast. 

The first step is recording scheduled revenue is to designate a system as a source of truth. This can be done potentially by creating a Scheduled Revenue Forecast in your CRM or within a spreadsheet. If you’re just making the shift to recognizing revenue based on service period, start simple. An export from invoicing tools like Harvest or QuickBooks can be used to import invoicing data so invoices can be associated with the correct service period for reporting. Similarly, native integrations or automated exports can be created between platforms used to manage client projects, ad spend and subcontractors to identify and subtract passthrough revenue from invoice totals. 

If you’re not sure where to start or have questions about developing an agency operation model, get in touch with us. We specialize in helping agencies improve profitability by focusing on the metrics that matter.