A Detailed Guide to Agency Accounting

Why is agency accounting important? Here is how to set up and manage your agency’s books in Xero

Many agency owners think the biggest reason why agencies fail is a lack of sales. This is rarely the case.

The biggest reasons agencies fail are lack of financial planning and poor cash flow management.

The silver lining is – it is easier to get your agency’s finances in tiptop shape than it is to land a bunch of new clients.

In this post, we’re going to walk you through everything you need to know in order to run a financially healthy agency.

Why is accounting important for agencies? 

Accounting is the backbone of your agency, and overlooking it or only addressing it during tax season can lead to significant problems later on. 

Optimizing financial performance involves identifying areas to cut costs and boost income, monitoring revenue and expenses, and planning for emergencies to ensure your agency is always prepared.

Know your numbers

In order to make smart decisions about your agency’s future, you need to have a firm grasp of your agency’s finances. 

Maintaining a clear record of your assets, liabilities, debt, income, and free cash flow is crucial for making informed decisions. This ensures your agency’s financial health and stability.

For instance, if you are six months behind on your bookkeeping or there are a ton of mistakes in your reports, you are not going to have confidence in your numbers. This means you are making decisions off of inaccurate data or going purely on intuition. 

A better way is to make decisions based on your data, which means you can understand how much free cash flow you have at any time, how profitable each project is, be able to pay your team on time each month (including yourself).  how much you can pay yourself each month

Eliminate tax time stress

When you are on top of your bookkeeping, putting aside money each month for taxes in a separate category or account and paying the right amount in quarterly taxes, the end of the tax year is a lot less stressful. You don’t have to dig through a year’s worth of receipts, deal with compliance issues, or worry about how you are going to pay your ginormous tax bill.  

This keeps your agency compliant with both tax laws and accounting standards in your jurisdictions. 

Keep to your budget 

Managing cash flow and budgeting helps maintain control over your agency’s finances and operations. This helps with resource and staff allocation, prevents overspending, and ensures you’re prepared for any financial challenges. Proper forecasting of income and expenses allows for effective planning, so your agency is always ready for contingencies and emergencies.

Ensure profitability for individual clients or projects 

Understanding the profitability of specific revenue streams, individual clients, and your agency’s overall performance allows for better strategic planning. By determining project profitability and ensuring projects stay on track, you can identify inefficiencies and areas for improvement. 

Pay yourself a livable wage 

Many agency owners either consciously or subconsciously make themselves martyrs for their own businesses. They either don’t pay themselves at all, pay themselves whatever is left over at the end of the month, or a “Ramen Noodles salary.”

As the owner of the agency, you should be compensated fairly for the work you do. This means paying yourself a livable wage in addition to quarterly or annual profit distributions. After all, it is your business, and you should be rewarded if it grows. 

Move away from DIY spreadsheets to cloud accounting software 

Many agency owners take the DIY approach to accounting and rely on Excel spreadsheets or, worse, bank balance accounting. The problem with this approach is you get a very limited view of your business’ finances. a

The first step to building a solid accounting foundation for your agency is to get out of spreadsheets and upgrade to cloud accounting software, such as Xero or QuickBooks. 

All cloud accounting software is faster, more reliable, partially automated, and less prone to human errors than DIY accounting in spreadsheets. It is also fully secure and encrypted, syncs with your bank and credit card accounts, and integrates with key business software like Gusto. 

Pro Tip: Want a step-by-step checklist for setting up and keeping your Xero account in order? Download our free Xero Toolkit.

Top cloud accounting software for agencies

We’ve already mentioned why it is a good idea to move away from spreadsheets and bank balance reporting and use dedicated cloud accounting software.

Here are solid, affordable options for agencies. 

Xero

Xero is a leading cloud-based accounting software designed to streamline financial management for small to medium-sized businesses. 

At Bean Ninjas, we’re partial to Xero. That’s because it is the most intuitive accounting platform for both agencies and accountants with its user-friendly design, responsive support, and competitive pricing. 

With invoicing, you can create and send professional invoices, track when they are opened, and set up automatic reminders. This means faster payments and less hassle.

The bank reconciliation feature imports and categorizes bank transactions automatically, making the process quick and accurate.

Xero also makes expense tracking a breeze. You can manage expenses and capture receipts using the mobile app and then update your chart of accounts.  

The financial reporting tools let you generate profit and loss statements, balance sheets, and cash flow statements easily. These reports help you understand your agency’s financial health at a glance.

Plus, its integration with third-party apps expands functionality, and project tracking helps you monitor time and costs for accurate billing. You own your Xero account and can invite accountants or bookkeepers to collaborate with you.  

Pro Tip: Want a step-by-step checklist for setting up and keeping your Xero account in order? Download our free Xero Toolkit.

Xero offers three different plans, starting at $15 per month for the lowest plan and up to $78 for the highest.

QuickBooks 

QuickBooks is the most popular cloud-based accounting software in the U.S. and is designed to simplify accounting and financial management for small businesses. With its invoicing tool, you can create and send custom invoices, track their status, and set up automatic reminders to ensure timely payments. The expense tracking feature lets you manage and categorize expenses while the bank feeds automatically import transactions, speeding up the reconciliation process and reducing errors.

Cash flow management in QuickBooks helps you forecast and manage your cash flow effectively. You can generate various financial reports, such as profit and loss statements, balance sheets, and cash flow statements, which give you a clear picture of your agency’s financial health. You can also integrate QuickBooks with 100s of third-party apps. 

QuickBooks Online offers four different plans, starting at $30 per month for the lowest tier and up to $200 for the highest tier. Plus, it offers a 30-day free trial. 

Wave

Wave is known for its user-friendly and intuitive interface, cost-effectiveness, and the fact that many key features are free to use, which is especially beneficial for freelancers and smaller agencies. 

With its free accounting and invoicing tools, you can track income and expenses, manage transactions, and create professional invoices. Custom invoicing features let you create, send, and personalize professional invoices. Wave also supports multi-currency transactions.  

Automation features like automatic bank transaction syncing and integration with payment gateways save time and reduce manual effort. Wave also makes tax preparation easier by keeping financial information and detailed reports organized and accessible. 

Wave offers two different plans. The starter plan is free, while the Pro Plan is $16 per month. 

FreshBooks 

FreshBooks offers a range of key features tailored for small businesses, agencies, and freelancers. Users appreciate FreshBooks for its intuitive, user-friendly interface.  

For instance, the invoicing feature helps businesses get paid faster by generating and sending invoices easily. Time tracking ensures accurate billing based on the time spent on tasks. And expense tracking allows you to monitor and categorize business expenses efficiently.  

Many customers like their built-in client management feature, which keeps records of client communications, project details, and payment history. 

In addition, built-in integration and automation features save time and improve workflow efficiency. 

With affordable pricing at a lower tier, FreshBooks is a valuable tool for agencies looking to streamline their financial processes. They offer three different standard plans, starting at $19 per month for the Lite Plan, and the Premium Plan fee is $60 per month. Additionally, you have the opportunity to speak with a specialist to customize a plan according to your needs.

Zoho Books

Zoho Books offers a suite of features designed to streamline agencies’ financial management. Users frequently mention the value Zoho Books offers for money, considering its extensive features and capabilities. It is particularly praised for its efficient invoicing and accounting functions, which are ideal for agencies. Creating customized invoices is simple, and you can automate recurring invoices and accept online payments. 

Expense tracking and connecting bank accounts are also efficient. So, you can either upload and keep track of receipts along with easy reconciliation of transactions. 

Collaboration tools built into Zoho Books allow you to invite team members, bookkeepers, or accountants to work together. They also integrate with most payment gateways, CRM software, and ecommerce platforms. 

Zoho Books offers six different plans and includes a free option available for businesses with annual revenue under $50,000 USD. Their highestplan is $275 per month. 

Set up your agency accounting tech stack 

In addition to your cloud accounting software – like Xero – you also want to make sure all of your other key business operational and financial software is integrated with it. If all of your key tools are synced, it means less administrative work for you and your team.

Your tech stack will expand as your agency grows, especially as you bring on full-time employees. Here is a few software we recommend adding to your accounting tech stack: 

• Xero – your cloud accounting software
• Hubdoc – This app makes it easy to manage receipts and expenses, and it comes free with Xero as of March 2020. 
• Gusto – managing employees and contractors invoices and payroll  

Decide which financial metrics to track  

When you are first starting out, we recommend keeping it simple and focusing on the basics:

• Revenue  – this is the metric that even the most stubborn, non financially savvy agency owner is likely tracking. It is top-line revenue or sales. 
• Profit – this is sales minus all of your expenses, which includes your own salary, staff costs, and any operating expenses. 
• Aged Receivables –  this is a term for any outstanding or unpaid invoices.  
• MRR – this stands for monthly recurring revenue. 

As you bring on more contractors and full-time employees, we’d also recommend tracking the following:

• Gross Margin – this is total revenue minus cost of goods sold divided by total revenue. 
• Project / Client Profitability – this is the value you charged less the costs to fulfill the work.
• Labor Efficiency – this is the gross profit per labour dollar spent 

Monitor key financial reports regularly 

Once you know which metrics are most important for your agency, it is time to build and review your financial reports on a regular basis (i.e. at least monthly). 

Here are the three reports that all agency owners should check. 

1. Profit and Loss Statement  

Your P&L gives you a snapshot into the health of your business by displaying all revenue and expenses in a given time period.

It is particularly useful to get ahead of potential problems before they turn into full-blown crises, like: 

• Declining profit for individual clients, projects, or the agency as a whole
• Declining spend in sales and marketing could signal less future growth 
• Agency owners aren’t paying themselves a fair market salary 
• Increase in staff costs as percentage of revenue 
• Increases in aged receivables (i.e. unpaid invoices) 

2. Balance Sheet 

Whereas your P&L can give you a snapshot into how your business is performing in a given month, quarter, or year, a balance sheet can provide the bird’s eye view on your overall investment. This paints a picture of all of your assets (what you own) and liabilities (what you owe).  

3. Cash Flow Forecast 

A cash flow forecast is like your business’s crystal ball. It allows you to map out different scenarios from best, moderate and worst case.

We recommend agencies update their cash flow forecasts at least once a quarter.

In order to create your first forecast, you need the following:

• Accurate, up-to-date bookkeeping records 
• Your beginning cash flow balance from that time period
• Revenue / cash inflows 
• Expenses / cash outflows

4. Bank Reconciliation Report 

Within Xero, you can run a bank reconciliation report. We often refer to these as balance sheet reviews. This allows you to spot any inconsistencies between your bank and credit card statements and your Xero account. This is especially important to run at tax time in order to ensure that you are reporting the right numbers, or else you could wind up under or overpaying. 

Pro Tip: If anyone on your team has access to your bank accounts, we recommend running a reconciliation report at least once a quarter. This is a way to get in front of any mistakes faster as well as ensure that no one is stealing from the company.

Agency accounting and bookkeeping best practices  

Accounting becomes easier when you build the right financial systems and processes in place. Here are the steps we recommend.    

Implement cash flow management best practices 

Having a cash flow management system, like Profit First, helps give you control back over where your cash is going.  There is often a disconnect between the accounting reports and what is happening in your bank account.

The usual symptoms of an unprofitable agency are:

• Cash flow shortages
• Your P&L says your have made a profit by there is no cash
• Struggling to hit payroll each month 
• Unable to pay yourself a decent salary 
• Owing back taxes and/or having to pay fines and penalties 

A cash flow management system solves this by clearly showing if you are running a business with the right margins.It is a subtle shift but forces agency owners to prioritize business profit and free cash flow.  

Send invoices quickly 

Every agency owner wants to get paid. However, many agencies send invoices later than they need to. This can result in cash flow problems.

One way to fix this is to create a system – ideally partially automated – around sending invoices and follow-up reminders. This ensures you get paid faster for the great work your agency does.  

Provide accurate estimates for new projects

Another way that agencies can get into trouble is underestimating the amount of time or money it is going to take to complete a project. 

When you are creating your proposals, you want to make sure to account for the project length, all deliverables, staff costs, and more to ensure you are can deliver the work profitably.  

Update your chart of accounts regularly 

Your chart of accounts is a categorized list of all of your transactions. It is best to update it weekly – or monthly for smaller agencies – so that you always know where you are spending your money. 

With Xero, you can even configure conditional logic and automated rules to automatically categorize many of these transactions. For example, you can create a rule to automatically categorize your monthly Slack fees in “software” category. 

Maintain compliance for payroll and taxes 

The added benefit of keeping your chart of accounts up-to-date is that it helps with tax compliance – especially if you want to deduct a lot of expenses.

In addition to making sure you are reporting accurate revenue numbers, you also want to pay close attention to payroll taxes and compliance if you have any employees.

Many agencies get into trouble because of payroll compliance issues. In fact, the IRS in the U.S. can even garnish your business revenue and even personal assets if you don’t pay payroll taxes and associated fines.  

Should you hire a specialized agency accounting firm?

As one of the pillars of a financially healthy agency, you can’t afford to skimp on accounting and bookkeeping.  

It is one of the reasons that an accountant is typically the first expert hired in an agency, usually for tax purposes. We recommend going a step further and hiring an accountant or accounting firm that specializes in working with agencies.

Despite knowing that you need to hire, it doesn’t make the process of actually finding, hiring, and vetting the right candidates or companies any easier. This is especially true for most agency owners, who don’t have a financial background to lean on.

In this case, the three most important things you can do in the hiring process are to:

• Seek out niche accountants or accounting firms that work mostly with agencies. This means they are familiar with your business structure and have likely encountered what you are encountering (or will encounter) before. 
• Share lots of information about your agency, goals, and challenges.
• Ask lots of questions.

If you only give them limited information, you will get basic advice and best practices. However, if you share more details about your growth objectives, a talented accountant can ask questions and provide insights that will help you evaluate if they know their stuff. 

Besides gauging their experience and credentials, ask questions to learn about how they like to work. For example, an accountant excitedly talks about the 105-point checklist they use with all of their clients is likely to have a dialed-in process. Since accounting is process-driven and detail-oriented, you want to hire someone who is methodical and likes to dive into the weeds.  

On the flip side, if you talk to another accountant, they describe how every client they work with is different, don’t have a detailed checklist, and “wing” it with all of their clients, you should run the other day. 

Pro Tip: Want more interviewing tips? Check out our detailed guide to hiring bookkeepers.

When to hire an in-house controller 

There are many different routes you can take when it comes to hiring, vetting, and working with accountants, bookkeepers, fractional CFOs, in-house controllers, etc.

There are pros and cons to all approaches.  If the budget is no concern and you are making over $10 million in annual revenue, hiring an in-house, full-time controller can be beneficial as you are paying them to work directly for your business. As a full-time employee, they will learn all of the intricacies of your business and can potentially help with more tasks as well as invoicing, payroll, HR, and managing any third-party firms and freelancers.

The disadvantages of hiring full-time employees are in associated costs, employee onboarding, and management time. For starters, you have them a full-time salary and benefits. That’s not cheap. It also takes a while to get them up to speed on your company, typically around 90 days. You also have the added time to manage them.

For most agencies doing less than $10M in annual revenue, the cost of hiring a full-time controller is likely overkill. When you are doing under $1M in revenue, a third-party specialized agency accounting firm or a tax accountant and freelance bookkeeper is likely more than enough. For instance, working with a partner like Bean Ninjas means you get the benefit of working with a service provider that has dialed-in processes, expertise, and relationships in the cloud accounting software you use. Plus, we specialize in working with agencies and eCommerce businesses, have a team of qualified accountants and bookkeepers, know the ins and outs of the Xero platform, and have relationships with people inside Xero we can leverage for support. You’d be hard-pressed to find that with either an in-house employee or a freelancer. 

Once you cross 7-figures, you may also want to bring on a fractional CFO.  This is a practical, cost-effective solution for getting financial advisory services.

Pro Tip: If you are looking for the absolute cheapest option, some agency owners like to have their VA do their bookkeeping in addition to general administrative tasks. While this can potentially save you money in the short term, this usually ends up resulting in additional headaches and expenses, which come at tax time when you realize your VA made a bunch of mistakes because they aren’t a professionally trained bookkeeper.  

Wrap-up 

Growing an agency is hard enough. When you ignore your accounting and bookkeeping, it only makes it that much harder.

The best thing you can do is set up solid accounting and bookkeeping systems and processes early on to help give you the quality data needed to make better strategic decisions. 

Want help setting up proper agency accounting systems and staying on top of your books? Schedule a free call to improve

Want to improve your cash flow and get more confident with your numbers? Learn how to use Xero effectively for your agency with our free Xero toolkit. This includes our step-by-step guide to getting your Xero file in order, a Cashflow Forecast Template, and a Bookkeeping timetable template to help you stay on top of your finances & get current reporting. Download here.