From our question bag (okay — from my inbox but you get the reference!). I’ve cleaned it up a little to protect the privacy of the agency asking the question.
Q: I am trying to understand what makes up the COGS number in order to calculate our AGI. We are a public relations agency. From listening to your webinar on Financial Matters, my takeaway is the one of the items to include in COGS is the cost of freelance contractors. I’m assuming there are other costs like annual subscriptions to services which are used in doing our work for clients should also be included.
A: Anything you use or pay to create in service of clients (freelancers, online tools, reference books, printing, photographers, postage, shipping, media placement, mileage to client meetings, influencer fees, etc.) are all COGS. They are COGS whether you bill the client for them or not.
A way to test this is ask yourself this question. If we didn’t have client XYZ, would we still incur this cost. If the answer is no — then it is a COG.
The things that should not be included in COGS are agency expenses (w2 people, benefits for those people, auto allowances, lawyer and accountant fees, rent, supplies, professional development, travel (unless it is client related)
Q: We also want to look at account level profitability. To calculate the cost per employee, I am including salary/wages, insurance and 401(k) benefits, cost of PTO/company holidays. My research into what percentage to use for overhead markup resulted in a wide range of figures – 80% on the high end; 50% on the low end. Do you have a recommended overhead percentage?
A: Well, as you know, this is an imprecise science at best. How do you account for the non-billable people’s salaries etc.? Do you amortize them over the account like overhead? I think you’re good with a decent approximation.
But, in general, I wouldn’t assign the overhead by person. The truth is, a $25K employee doesn’t use up more overhead than a $75K employee. Unlike salaries, it’s really is uniform across the entire employee base — billable and non-billable.
I’d take 12 months of overhead and get an average monthly amount. Then, I would divide it by the number of employees for that month…and assign that $ amount to each person. It’s going to change a bit every month but I wouldn’t bother to do the math over every month. I’d pick a per head overhead cost for the quarter and if nothing big changed (more or fewer people etc.) I’d let it ride.
If your billable to non-billable people ratio is in a good place (about 5 to 1) then it ends up accounting for about 80% of the overhead when you attached the costs to your billable people.
Be careful in calculating this. You can spend months counting grains of sand when really you just need to be able to see if the sand bucket is overflowing or not.