Episode 178

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Agency owners are notoriously ill-informed (and uncomfortable) when it comes to their agency’s finances. Which means they make important decisions in the dark. Not ideal and we’re trying to change that at AMI. That doesn’t mean you need to understand all the fine-grain details. But you do have to understand where you stand financially at any given time.

On episode #178, I talk with Jenn McCabe, who started out in accounting at Ogilvy and Mather but soon started her own accounting firm to help small to midsized agencies figure out their numbers.

The numbers you need to know (and if you do any AMI planning, this will sound familiar) should fit on one sheet of paper. We’re not talking about miles and miles of Excel spreadsheets. Just the key figures and concepts you need to understand your agency’s financial health.

We’ll also talk about best practices for preparing your agency for sale when the time comes.

Recently Jenn merged her company with Armanino. They provide, among many other services, outsourced accounting, finance, and HR, working primarily with agencies to create simple accounting dashboards and financial documents that allow the agency owner to make good decisions.

 

 

What You Will Learn in This Episode:

  • The difference between cash accounting and accrual accounting (and why you NEED to know the difference)
  • The need for accounting rather than bookkeeping
  • Understanding run rate, aka your monthly “nut”
  • Why you need to pay yourself as an owner
  • Best practices around owner salary
  • How much cash and cash equivalents to keep liquid and available
  • How to be an attractive acquisition target
  • Transitioning your employees to new owners
  • Managing an internal agency purchase
  • Why management buyouts are becoming less common

The Golden Nuggets:

“Two things lower the value of an agency looking to sell: a client list with one or two gorilla clients, and a team that is iffy about staying past the acquisition.” – Jenn McCabe Share on X “It’s important to set goals and let everyone in the agency know what those goals are, what the numbers mean. The clearer the target, the more focused everyone will be on hitting it.” – Jenn McCabe Share on X “It is my mission in life to help people understand why they need accounting rather than bookkeeping.” – Jenn McCabe Share on X “It is costly in the long run to have unprofessional accounting.” – Jenn McCabe Share on X

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Ways to Contact Jenn McCabe:

Speaker 1:

Are you tired of feeling like the lonely lighthouse keeper as you run your agency? Welcome to the Agency Management Institute Community, where you’ll learn how to grow and scale your business, attract and retain the best talents, make more money, and keep more of what you make. The Build a Better Agency Podcast is now on our third year of sharing insights, and how small to mid-sized agencies survive and thrive in today’s market. Bringing his 25 plus years of experience as both an agency owner and agency consultant, please welcome your host, Drew McLellan.

Drew McLellan:

Hey, everybody. Drew McLellan here with another episode of Build a Better Agency. One of the pain points for many of the agencies that I talk to revolves around accounting and financials. The truth is that it is a rare agency owner who is actually somebody who comes out of the financial world.

Every once in a while, I will bump into an agency owner who loves spreadsheets and understands the inner workings of P&L statements and all of that, but for the most part, most of us came up through the agency world, and avoided accounting and Math courses in college as we made our way to our profession and, certainly, in our daily professional lives for at least a while didn’t have to worry about that. Now as owners and leaders of an agency, obviously, the financial health of the agencies becomes critical.

I’ve been talking to several agency owners lately who have literally said to me, “I have no idea where we are financially. There’s something wrong with our books. I don’t know how to read this. I’m not sure where the money is going.” How many times have you thought or heard someone say, “I owe a bunch of taxes, but I have no money. I can’t figure out how that works”?

So, I think the whole idea of understanding how the money works and how to have better accounting documents, how to have better financial documents that allow you to not only see where you’re at today, but look down the road and see where you’re going to be in the next 30-60 days is really critical.

So, my guest today is well-poised to chat with us about that and to talk about how agencies can stay ahead of themselves financially and make better decisions with better data.

So, Jenn McCabe started her career working at Ogilvy inside their accounting department, and then quickly leaped out and started her own, basically, an outsourced accounting and HR company. Then recently, she merged her company with a larger firm called Armanino, and what they do is, again, they’re an outsourced HR and finance company, and they work primarily with agencies, trying to help them have great dashboards and some simple financial documents that allow the agency owner to make good decisions.

So, I met Jenn a while ago, and we had a really great conversation around how to help agencies wrap their hands around the financial aspects of their business and, really, what are some of the key elements and indicators that agencies really need to be watching on a weekly, monthly, quarterly basis to make sure that they are tracking what they need to track.

So, one of the things I want to do with this episode, we also put together a list of what I think of as are the Key Performance Indicators or KPIs that many agencies should consider putting into their dashboard, and I’m going to make sure that that AMI document is at the end of the show notes, and I know that Jenn is going to have some things for us to add there as well. So, with that, I want to just jump right in to the conversation and let’s talk money.

All right. So, without further ado, Jenn, welcome to the podcast.

Jenn McCabe:

Hi, Drew.

Drew McLellan:

Hey. So, I know that I just told everybody all about you, but I suspect I didn’t tell them all about you. So, how is it that you came to be doing the kind of work you’re doing helping agencies with this whole finance thing?

Jenn McCabe:

Well, I started a long time, a long time ago, I won’t say how long ago, but I started at Ogilvy and Mather. Back when I was at Ogilvy and Mather, they were building what they called Ogilvy Orchestration, which meant they were grabbing and buying public relations companies, and direct response companies, and television production and radio companies. I was working at the big agency, and they had a training program back then that allowed me to work in every department of that big agency, and I went back and forth to New York a lot. I helped them put in the first nationwide computer system. It actually connected all of the offices, so Atlanta and New York. We’re talking to each other.

So, I got to be on the very front of agency technology, and I got to learn about the little companies that a big agency was pulling in, and it turned out that the little pieces were more fun. They were nimble and they reacted quickly to market, and the big agency was a lumbering giant, and I became a corporate dropout as I watched what the big agency was doing, and I got addicted to their little companies and to working with the guys they put in charge of these little production pieces that were 20 people or I would go onsite to a production in Canada.

I just got really passionate about the industry because I learned a ton about all the pieces of it and also about the little businesses that are all connected in peripheral to advertising. So, I started my company when all my friends started dropping out of the big agency and starting their own production companies and their own little agencies. As they became corporate dropouts, they just started coming to me, and I accidentally became, I like to say I’m like Algor. I like to say I invented outsourcing.

Drew McLellan:

There you go. With no doubt, just as much accuracy.

Jenn McCabe:

Yeah, I’m sure.

Drew McLellan:

Yeah. So, today, if somebody’s going to hire you, Jenn, they hire you to do what, if an agency hires you?

Jenn McCabe:

Usually, I get a call from a small agency person and by small, most of them have less than 25 people when they call me, but almost always less than 50. Every once in a while, they have, right now, we have somebody with 700 employees, but, generally, they’re small. They call because they’re realizing they need real accounting and they need someone to help them figure out if they’re making money. They call because they’re scared and they don’t know if they’re doing it right. A lot of times, they have also dropped out of a big agency. So, they know that they need information. They don’t even know because all my friends are creative people. They don’t even know what to ask for. They do know they wish they could talk about their company’s finances at a dinner party.

Drew McLellan:

Okay. All right, or at least lie about their company finances at a dinner party.

Jenn McCabe:

Exactly.

Drew McLellan:

Right?

Jenn McCabe:

Right. They want to be able to tell their bros that they’re making money or not making money. A lot of times, people call me and say, “I don’t have a lot of money in the bank, but I owe taxes.” That doesn’t make sense to me or, “I got to hire someone because I’m working my teeth off, but I don’t think I can afford it,” and the answer is usually, “Well, we need to look at your numbers,” and they say, “What?”

Drew McLellan:

Yeah, “What numbers should I look at?”

Jenn McCabe:

Yes, “What?”

Drew McLellan:

Right. So, let’s take that scenario. Somebody says, “I need to hire somebody,” or “I have to pay taxes,” because they’re really the same question, right? “I need to hire someone but I don’t have the money,” or “I have to pay taxes and I have no money in the bank.” How is that possible? What do you go in and look at?

Jenn McCabe:

The first thing I see, the two mistakes I see over and over are they’re doing cash accounting. That means that they’re recording expenses when they write the check, and they’re recording income when it gets deposited into the bank. That sounds perfectly logical to anyone who hasn’t taken an accounting class. So, I have to explain to them that there’s a reason that in Corporate America accrual accounting is actually legally required because accrual accounting ac tells people how they’re doing. Most people run their business out of their checkbook, money in and money out.

In our business, if you’ve done a good job of billing upfront, so say you’ve billed 50% upfront or even 100% if you’re really cruising, unfortunately, all the money that you pay out hits two months later, and it really messes people up. This jerkiness of cash makes them not know where they are. That’s the number one mistake.

The number two mistake is they have underestimated the importance of having accounting instead of bookkeeping. It’s my mission to make bookkeeping illegal, at least unlicensed bookkeeping. There are a lot of well-meaning people out there who are very organized and very meticulous. Sometimes it’s this person’s family member who’s keeping track of everything for them, and it’s cost effective in the short run and very expensive in the long run to have unprofessional accounting.

Drew McLellan:

So, define for me the difference between accounting and bookkeeping.

Jenn McCabe:

Bookkeeping is paying the bills, depositing the checks, typing up invoices to clients, and just letting it hit the bank, and really taking care of the bank account. The bank account is just one-

Drew McLellan:

Right. It’s really taking care of accounts receivable and accounts payable.

Jenn McCabe:

Yeah. By the way, I see in a lot of startups they’re not even really doing that because when you say accounts receivable and accounts payable, you’re assuming that the people listening to us understand that to have a payable account, it means that you have to book all the bills that are going to be paid, not just when you write the check, but, one, as it comes in the door and you put it in the pile of, “Oops, I got to pay that next week,” you book it, so that you have a report.

I always teach people that the accounts payable report is a to-do list of all the bills that you have to pay, and an accounts receivable report is a list of all the people who owe you money. Most startups have a folder or maybe a Google Doc. The new folder is a Google Doc with all the people who owe them money in a list that’s not in their accounting software.

Drew McLellan:

Okay. I’m really hoping most of my listeners have gone above that. So, when you and I talked on the phone before we got to know each other, one of the conversations that I think we bonded over was this whole idea of in any accounting software, assuming that you are logging in things into accounting software, where do you put contract labor? So, today, so many agencies either are virtual agency and they have no W-2 employees or many agencies-

Jenn McCabe:

Oh, oh, you just gave me a rash.

Drew McLellan:

Hang on, or most of them have a high bred, where they have some W-2 employees, again, whether they’re a brick and mortar or virtual, and then they also use contractors for skills or deliverables that maybe they don’t do often enough to need full-time employees. So, I know you are in California. So, we’re going to put that aside for a second.

So, for the other states, that’s still a feasible option, but what I want to talk about is not whether or not you should use contractors. What I want to talk about is how you record that expense so that your financial metrics line up? So, we had an interesting conversation about, is it a cost of goods or does it drop down below the adjusted gross income line? Do you want to talk about that a little bit?

Jenn McCabe:

Yes. Again, we’re talking about startups and smaller agencies.

Drew McLellan:

Well, but keep in mind, most of my agencies who are listening have been around for 20 years. So, they’re not startups, right? So, how are you-

Jenn McCabe:

Okay. So, they’re what size would you say?

Drew McLellan:

It could be anywhere from 10 people to 500 people, but the point is they’ve been around for a while. So, they have been behaving in a certain way for a while, and a lot of them are in some accounting software. Nonetheless, they wrestle with this idea of, “Well, I’m paying this contract person to do-”

Jenn McCabe:

“Where do I put them?”

Drew McLellan:

“Where do I put them?” Right.

Jenn McCabe:

“Where do I count my money or don’t?” So, I think that even in my big agencies, it’s best to keep the financial statements simple. So, I fight the fight to keep the profit and loss statement or the income statement one page long so that when I’m talking to my owners, it’s one page. If it’s more than that, they see squirrels out the window and don’t pay attention. That’s part one.

To keep it simple, part two, when yo hire cost that is specific to a job that we’re doing and we are gig to gig in this industry-

Drew McLellan:

Right. So, we’re hiring web developers, let’s say.

Jenn McCabe:

Yeah, and if it’s a web developer that is for just a gig and it’s on the SOW to the client, I go ahead and put that above the line. It’s what I call a direct expense, and it’s only for that gig, and it’s also the most important term that I want to get across everybody to get is variable versus fixed.

Drew McLellan:

Absolutely.

Jenn McCabe:

So, what people get all caught up in their underpants over is direct and indirect cost. If they hire Jenn McCabe and she’s going to work on a gig, sometimes it’s direct and sometimes it’s indirect. I think that that just complicates thing and it’s just much better to say, “I’m going to put all of my fixed expenses below the line in my operating expenses. So, if I have Jenn McCabe over and over and over, and she works some of the time on direct gigs and jobs and sometimes not, but I’m going to have to pay her no matter what month after month after month like a lot of my salaried people.”

I like to put that in the operating expenses because it’s fixed. Even I don’t have any work, I’m going to have to pay those costs. So, what you end up with is above the line as in above gross profit or above income as well. I like to have on the top, billing minus cost of sales. Billing is what you send to your clients. Cost of sales are all of those cost that are really specific to that gig that are on the estimate to the client, and what you’re left with is what we call income in the industry a lot of times, income after pass through expenses.

Drew McLellan:

Yeah. So, in AMI vernacular, that’s adjusted gross income. So, you have your gross revenue minus your cost of goods, and then we have adjusted gross income, and out of the adjusted, and what adjusted gross income should cover is your W-2 folks and their benefits, your overhead expenses and, hopefully, there’s money left over for profit and taxes and all of that sort of thing, right?

Jenn McCabe:

Yeah. So, when you look at your profit and loss statement, you can almost exclude everything above that gross income that your gross adjusted income. Anything above that is just going through the washing machine.

Drew McLellan:

Right. Yeah. You’re being a bank, right?

Jenn McCabe:

Yup. Absolutely. It’s really because we call ourselves agencies. There’s a legal reason for that word. It means that you are the agent for your client and you are just paying their bills. So, that to me doesn’t apply to my staff. Their my staff. They’re not agent expenses. So, I put everything below the line that is fixed, isn’t variable, and it helps me identify for an owner what I call the run rate. So, every month, that should be a pretty fixed amount.

Drew McLellan:

So, define a run rate for people who are not familiar with that term.

Jenn McCabe:

A run rate is how much do I have to spend to keep the lights on? Even if I don’t get a nickel of work, what am I absolutely committed to? That’s a really important number for a business owner to know. That’s the number at the cocktail.

Drew McLellan:

Let me just make sure I’m tracking with you. So, what you’re really talking about is that’s my monthly nut. I have to pay my people, I have to pay my rent, and my overhead expenses. That’s the amount of money that I need to have without any profitability, whatsoever, just to keep my business open.

Jenn McCabe:

Yeah, and depending on the philosophy of the agency that I’m working with, sometimes the owners like to have their guaranteed payroll in that monthly nut, and sometimes they don’t. Sometimes they say, “Okay. What’s my run rate without me in it, and what’s my run rate with me in it?” Sometimes they want their taxes included or not, but it’s the cocktail party number. It’s when you’re hanging out at the cocktail picnic, you want to say to someone, “Yeah, it costs me $100,000 a month just to keep the lights on.”

It’s important in goal setting because then agency owners and all of their people that they put on a goal plan know what they have to go out and get every month. Now, if-

Drew McLellan:

Right, which, by the way, is why I think it’s, and I’m curious about your opinion about this, but I think, too, for the owner to exclude their own salary means that, really, they’re running their business inefficiently, which means that they are not actually running their business the way it should be run because nobody is doing this for free, right?

Jenn McCabe:

I agree.

Drew McLellan:

So, what it allows them is it allows them to be a little fat in the staff side or on the overhead side as opposed to running their business well, and I find that most owners who do that are doing it so they don’t have to make the difficult decisions that they should make about cutting staff or cutting expenses or something else.

Jenn McCabe:

Agreed. Interestingly, because I also do mergers and acquisitions work a lot, so I help agencies start and take them all the way through exit. Now that I’m getting along in my years, I’m starting to help people buy themselves back from the big networks, which is really fun work.

Drew McLellan:

Interesting.

Jenn McCabe:

Yeah. It’s very interesting. I’m working with some people now who are buying themselves back from one of the big networks. It’s my second time around. In my career, that wasn’t how it went. So, I’d always build agencies and sell them. What has happened lately is people get referred to me because they wanted to drop their agency to one of the big networks. They will come to me with the financial statement where the owner has been excluded or paid too little and they’ve had financial advisers or maybe investors who wanted to see a bottom line margin.

They have done all sorts of things to hit that margin because they were told that that would help their multiple, which is flat out wrong because when you do evaluation, of course, you have to go in and do what we call a minus back when you haven’t paid the owner enough. What I don’t like-

Drew McLellan:

You have to normalize the books, right?

Jenn McCabe:

Absolutely. So, I also have to compare a lot of agencies to each other and people ask me to benchmark a lot. They say, “How does my agency look compared to my nextdoor neighbor’s agency? What’s my margin?” I can’t benchmark an agency that isn’t paying its owners because it’s nonsensical.

Drew McLellan:

Right. It’s not real life and it’s not sustainable. Nobody can work for free forever. If you have that much money, you don’t own an agency anymore, you’re doing something else.

Jenn McCabe:

That’s right. Yeah. It doesn’t make any sense. I really try to fight with people to make sure that they’re paying themselves something that’s fair and square.

Drew McLellan:

Yeah. What is your recommendation in terms of doing that in the mix of W-2 and dividend income? Do you have a formula that you like to follow with your agency owners of how much they pay themselves in each of those two buckets?

Jenn McCabe:

Well, I’m a recovering tax person, so the reason I’m recovering is that I like to be able to operate on a continuum of risk as I say instead of by the book. So, when you an S corp, which is what I had until I merged my company with Armanino, so I practice what I preach. You pay yourself a salary and it’s a tax, this first part of my answer is a tax answer. You pay yourself the minimum acceptable salary because then you have a lot more in dividends. Dividends are taxed at a lower rate than your wages are. We have to weigh that because you might want your wages to be high because of your retirement contribution, for example.

Then there’s this other thing for the valuation and for the internal revenue service. You need to pay yourself a reasonable wage. I li