Accounting for a marketing agency: the basics to set up first

What accounting does a marketing agency need?

It needs a business bank account, one accounting method picked with an accountant, and books kept on that method from the first invoice.

Under IRS Publication 538, a taxpayer must stick with one accounting method. A method, in the IRS's terms, is the set of rules that decides when income and expenses get reported. It also names the cash method and the accrual method as the two used most often. Here's how they differ:

• The cash method. You generally count income for the tax year in which it reaches you. You deduct an expense for the tax year in which you pay it.
• The accrual method. You generally count income for the tax year in which you earn it, even if the client pays later. You deduct an expense for the tax year in which you take it on, even if you pay later.

It also says that many small businesses use the cash method, as do most individuals, and that some kinds of business generally can't use it, which it lists by name. It also says that once you've picked a method and filed your first return on it, changing methods generally takes the IRS's approval. So pick your method with an accountant, and check it against the IRS's list before your first return.

Then set up the books in this order:

1. Open a business bank account and card. Run every agency dollar through them, and keep personal spending off them.
2. Choose your method with your accountant. Set your books to it from the start.
3. Set income categories by service. Web work, content and email each get their own line, so you can see what sells.
4. Save receipts as you go. Keep them in one place, tied to the expense they back up.
5. Book a monthly close. Pick a day each month to match the books to the bank and read the reports.

California adds two taxes to know about. Each year, an LLC organized in California, or doing business there, owes the state an $800 tax. Once that LLC's California income reaches $250,000, it also owes a fee, which starts at $900.

Sales tax is the other one. California's Regulation 1540 covers advertising agencies. It treats the design, editing or hosting of a website as a service when nothing physical is handed over. In the rule's words, the charge "is not subject to tax". The same rule says certain other fees, media commissions among them, aren't taxed when the invoice lists them on their own lines. Ask your accountant whether sales tax applies to what you buy.

Both taxes sit with the other state rules an agency runs into as it grows. For those rules and the official pages behind them, see What does California require before I hire or contract help?.

How should a digital marketing agency track profit by client?

Tag every dollar of income, and every hour and cost of delivery, with the client it belongs to. Then take each client's costs from what that client paid.

1. Give each client one tag. Use the same tag in your books and in your time tracker.
2. Put that tag on every invoice line.
3. Log staff and contractor hours by client and by task.
4. Put a cost on those hours. Use what you pay for an hour of each person's time.
5. Tag costs bought for one client to that client. A stock photo or a plugin for one site counts.
6. Run the sum each month. Take each client's costs from that client's income, then divide what's left by the income.

That last step gives you a margin for each client. For working out your margin, see marketing agency profit margins.

Hours go missing when nobody logs them. Ask everyone who touches client work to log time against the client tag. For tracking hours, see agency time tracking.

Which marketing agency accounting reports matter each month?

Read five each month: profit and loss, the balance sheet, cash flow, unpaid invoices by age, and profit by client. Together they tell you whether you made money, whether you can pay your bills, and where the money comes from.

• Profit and loss. Income, costs and what's left for the month. It shows whether the agency made money.
• Balance sheet. What the agency owns and owes on one day. It shows whether debts are growing.
• Cash flow. Money in and out of the bank. Profit on paper can still leave the account short.
• Unpaid invoices by age. Who owes you, and for how long. Late payers cost you cash even when the work earns a profit.
• Profit by client. Each client's income minus that client's costs. It shows which clients carry the agency.

Bring in an accountant at these points:

• When you form the business and pick your method.
• Before you file your first return.
• When you start paying staff.
• When you're unsure whether a tax applies to something you sell or buy.
• When the reports stop making sense to you.

We don't give legal or tax advice, so check your own case with a lawyer or an accountant.