Client profitability for marketing agencies

Client profitability is the contracted revenue for a period minus the labor cost that client absorbed in that period. Most agencies get it wrong in both halves: they count logged hours times billing rate as revenue, and they divide salaries by hours logged as cost, which hides over-servicing on one side and idle time on the other.

This guide walks through the correct method with a 12-person agency, a $15,000 per month retainer, a $150 blended billing rate and salaried staff costed at 173.3 hours per month.

Why does hours times billing rate overstate revenue?

Because the client did not pay it. Take the $15,000 retainer client. In August the team logged 146.7 hours against that account, which at $150 per hour is $22,000 of value. The invoice was $15,000. Revenue was $15,000.

The $7,000 gap is not income the agency earned. It is over-servicing, hours delivered for free beyond what the retainer funds, and it belongs in the servicing gap line as a cost signal. A profitability report that shows $22,000 of revenue for this client tells the owner the account is thriving when it is being subsidized.

The reverse error also happens. A client that logged only 60 hours against the same $15,000 retainer shows $9,000 of "revenue" under hours times rate, which understates what was actually billed and makes a profitable account look weak. Neither number is what the bank statement says.

What counts as contracted revenue for the period?

Contracted revenue is what the client agreed to pay for the period, straight-lined across it. For a monthly retainer, that is the retainer amount. If the client pre-paid an overage block, the block is recognized over the period it covers, not in the month the cash arrived.

Pass-through costs such as ad spend are excluded from both revenue and cost when measuring labor margin, because the agency carries no labor in them. See revenue recognition for retainers for the timing rules.

How should labor cost be calculated?

Hourly staff are costed at their hourly rate, including employer taxes and any benefits, times hours logged. That is the straightforward half.

Salaried staff are costed at fully loaded monthly cost divided by 173.3 hours. The 173.3 figure is 2,080 working hours per year divided by 12 months. This gives a stable cost per hour that does not move with how many hours the person logged in a given month.

Absorbed cost for a client is hours logged to that client times the cost per hour of whoever logged them. Idle time is monthly cost minus absorbed cost across all clients. It is reported on its own line and belongs to no client.

Why does dividing salary by hours logged make idle time disappear?

If you cost a $10,000 per month employee by dividing salary by hours logged, their cost per hour changes every month and the client absorbs the consequences of the agency's staffing decisions.

The same 60 hours of the same person's work cost the client $6,667 in a slow month and $4,286 in a busy one. Nothing about the client changed. The agency had 83 idle hours in the first month and 33 in the second, and the method smeared that cost across whichever clients happened to be active.

At the 173.3 method the client's cost is $3,462 in both months. The unlogged hours, 83.3 in the slow month and 33.3 in the busy one, cost $4,806 and $1,922 at $57.70 and show up on the idle line where the owner can act on it. Idle time is a capacity problem, not a client problem. Verbial computes profitability from contracted revenue and absorbed cost with idle time on its own line.

What does a full worked example look like for one client?

Here is the $15,000 retainer client for August. Total logged hours are 147, which at $150 is $22,050 of value at billing rate.

Now the two methods side by side.

Same client, same hours, same people. The first column says this is a 66% account. The second column says it is a 50% account carrying $7,050 of unpaid work, which is 47 hours the retainer did not fund. The second column is the one that matches the bank.

How does margin compare across clients?

Run the same calculation for every client and put them side by side. Here are four accounts from the 12-person agency for the same month.

Client D is loss-making. Its $6,000 retainer consumes 85 hours, more than double what $6,000 buys at $150, and most of those hours are the PR director at $63.47. Under hours times rate it would report $12,750 of revenue and a 46% margin, and nobody would look at it.

Client C is the quieter warning. It is profitable but at 34.2%, well under the 40% floor, and it is absorbing 118 hours against an 80-hour retainer. Both accounts need a decision. The effective hourly rate makes the same point from the other direction: Client D earns $70.59 per hour delivered against a $150 list rate.

What is the difference between gross and net margin?

Gross margin on labor is contracted revenue minus absorbed labor cost. It answers whether the work itself makes money. See agency gross margin.

Net margin subtracts everything else: idle time, non-billable leadership and sales time, rent, software, insurance, professional fees and the owner's own cost if it is not already in payroll. It answers whether the agency makes money. See net margin.

Idle time sits between gross and net because it is a real cost of the agency but not a cost of any client. Charging it to clients makes good accounts look bad and hides the staffing problem.

What are the benchmarks?

A client at 60% or above is usually either priced well or under-served, and it is worth checking which. A client between 40 and 50% is fine if it is growing or strategically important. Below 40% is a decision, not a data point.

What should you do with a loss-making client?

There are four moves. Work through them in order and pick one per client, with a date.

Reprice first because it is the only move that does not change the work. Rescope second because it keeps the client. Reassign third because it changes who the client talks to. Exit last, and only when the numbers still do not work after the first three.

Set a review date 60 days out. If the account has not crossed 40% by then, escalate to the next move.

Who should see what?

Margin exposes salaries, so access follows the role model. Members and managers see hours only. Account managers and directors see budgets and revenue, which is enough to manage pacing and scope. Admins see cost, salary and margin.

An account manager who can see that Client D is at 85 hours against a 40-hour budget can act on it without knowing what the PR director is paid. That is the right split. Full detail on the calculation lives at /product/profitability. Compute it every month, for every client, and act on the bottom two.