Realigning Financial Reporting For Agencies

 

Faster Isn’t Always Better

For many agencies, the way you record revenue and expenses can lead to inaccurate and misleading financial statements. This doesn’t mean that the financial statements are wrong; rather, it’s about making sure they show an accurate and realistic picture of how money is coming in and out of the agency. 

To remedy this, agencies should be recording income and expenses on an accrual basis versus recording all income the moment a client’s payment clears. 

 

Accrual-based Accounting Strategies

Under accrual accounting, revenue should only be recorded when it’s earned — that is, when the work has actually been performed, and the associated costs have been incurred. However, many agencies fall into the trap of immediately recording revenue when they bill clients, even if that billing is for work not yet completed.

This disconnect between when revenue hits the books versus when the associated expenses hit can throw an agency’s financial reporting into disarray. 

Example:  an agency may bill a client in April for work to be done in May. They then improperly record that April billing as revenue right away, rather than deferring it until May when the costs will be incurred in the future.

The result is a lack of alignment between revenue and expenses across time periods. Revenue could be overstated one month, expenses understated the next. This makes metrics like gross profit margins unreliable for judging performance month-to-month. As Sara Snyder explains, it gives “an inaccurate view of their AGI (net revenue) and EBITDA. Those things are highly important.”

 

Using Magic Spreadsheets

Something that can help agencies get their financial reporting in order is a magic spreadsheet. This concept was developed by our friends at AMI to use in their peer groups to get a better view of their financials.

Magic spreadsheets allow agencies to see a “snapshot” of key financial metrics each month, rather than just at quarterly or less frequent intervals. These metrics tend to focus on analyzing AGI (adjusted gross income), or revenue minus cost of sales. 

 

Sticking to Accrual Based Accounting Principles

As Sara explains, if the accrual accounting foundations are not properly in place, that monthly snapshot becomes unreliable and loses its usefulness. 

The solution? Strict adherence to accrual accounting principles around revenue recognition. For any upfront billings, the cash received should be booked as deferred revenue. Then, revenue should only be recognized on the income statement in the period once the associated work is performed and costs are incurred.

 

Adjusting Systems and Processes

This can require some time and adjustments to your usual systems and processes. Recurring entries are often utilized to automatically transfer the right amount from deferred revenue to revenue each month as work is completed. It may take some upfront effort, but getting this right is critical for meaningful financial reporting and analysis.

By aligning revenue and expenses correctly using accrual accounting, agencies can trust that their monthly “snapshot” from magic spreadsheets accurately reflects the ebbs and flows of their business. They gain the ability to make staffing, pricing, and other key operational decisions based on reliable data about current profitability.

 

Conclusion

Proper accrual accounting and revenue recognition won’t happen overnight. But they’re essential for any agency wanting an honest picture of its finances to help it manage the business optimally. 

To learn more about how agencies can improve their financial statements and revenue outlook, tune in to this episode of The Progressive Agency Podcast to hear more from our guest, Sara Snyder.