Employee versus contractor — where do they live in your P&L?

This may be one of the hottest debated topics when it comes to agency math.  Many generalist accountants want to include ALL labor expenses in your cost of goods.  Others, want to just include your billable staff in cost of goods and count your non-producers as overhead. All of them are wrong when it comes to agency math.  This is why you need an accountant with lots of experience working with agencies. Before we dissect this… let’s review. Gross billings is everything that shows up on all of your invoices to clients. Cost of goods (COGS) are expenses you incur on behalf of a client (media, printing, photography, influencer fees, contractors/freelancers, etc.). The key to this is… if you didn’t have a particular client or weren’t working on a particular project, you would not just buy these things or give these people money. Adjusted gross income (AGI) is what’s left after you subtract the cost of goods from your gross billings.  AGI is the money you get to keep to run your agency.  You use that money for your loaded payroll/people expenses and overhead expenses, and hopefully, there’s some left over for profit. ANY employee (not a contractor or freelancer) falls below the line and is part of your adjusted gross income calculations.  It’s the only way all financial metrics/KPIs specific to agencies will work.  But what about contractors? It used to be very simple.  All contractors, except for outsourced admin resources like an accountant or attorney, were coded as cost of goods. This will be easier to understand if we get specific.  So, let’s create a cast of characters. Babette is a W2 (in the US) employee Jack is a US-based independent contractor/freelance graphic [...]