Marketing agency profit margins: how to work them out and what moves them

How do you work out a marketing agency's profit margin?

Take your costs away from your revenue, then divide what's left by your revenue. The costs you take away decide whether the answer is your gross margin or your net margin.

In words, the two sums are:

• Gross margin equals revenue minus the cost of delivering the work, divided by revenue.
• Net margin equals revenue minus every cost, divided by revenue.

To run them for your agency:

1. Pick one period. Last month or last quarter both work. Use the same period for every number.
2. Add up revenue. That's what clients were billed for your work. Leave out money that only passed through you, such as media you bought for a client and billed back at cost.
3. Add up delivery costs. Staff time on client work, contractors, partner fees and tools bought for one client all go here.
4. Find the gross margin. Take delivery costs from revenue and divide by revenue.
5. Add up everything else. Rent, software the whole agency uses, time spent on sales and admin, insurance, and your own pay.
6. Find the net margin. Take all costs from revenue and divide by revenue.

Your own pay counts as a cost in the net sum. Put a price on your hours equal to what you'd pay a hire to do that work. Without it, a busy owner can show a healthy margin while working for free.

Each margin moves for its own reasons. Gross margin moves with your prices, with how many hours a job takes in practice, and with who does the work. Net margin moves with all of that, plus overhead and your own pay. So a low gross margin points at pricing and delivery. A good gross margin with a thin net margin points at overhead. For the levers that raise profit, see how to increase agency profit.

Is a digital marketing agency profitable, and how can you tell from your own numbers?

It's profitable when money is left after every cost, your own pay included. If your net margin is above zero, the agency makes a profit. If your gross margin is fine but nothing is left below it, the client work pays for itself and the agency around it doesn't.

To read your own result:

• Run the net sum for several months in a row. One good month can hide a slow slide.
• Check that your pay sits in the costs. If it's missing, the net margin reads too high.
• Work it out client by client. A total that looks fine can hide one client who costs more than they pay.
• Put profit next to cash. Profit on paper isn't money in the bank until the client pays.
• Watch the trend. A margin that drops month after month needs a look before it turns negative.

These checks only work on clean books with costs sorted the same way each month. For setting up the books, see accounting for a marketing agency.