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Overhead Allocation FAQs
Summary: Frequently-asked questions about allocating overhead to clients, the Overhead Allocation Worksheet, and how overhead affects the Client P&L Analysis which allocates overhead expenses to clients. The overhead allocation function lets you calculate your shop's overhead with no rekeying of data. Instead, it uses the overhead expense totals from your General Ledger and client hours from Time Sheets to distribute each client's share of the agency's overhead expenses based on different industry approved formulas.
Q. Why is overhead allocation important?
According to the AAAA, overhead represents almost 50% of a typical agency's total operating expenses. It is the rent, utilities, office supplies, and other expenses used to run the shop and service the agency's client accounts. By allocating these overhead expenses to each client, the shop has the ability to see what the true service cost of the account is -- and if the account actually makes money for the agency. Once you know each client's true profitability, you can more effectively allocate people, facilities, and other resources to your most valuable clients. You'll also know as well which clients may not be worth keeping.
Q. Why doesn't Clients & Profits allocate overhead automatically?
Not all shops allocate overhead the same way because there are multiple accepted methods. The way agencies and design studios determine client profitability depends on their client mix, their business model, and their billing practices. Some will allocate overhead based on billings, the gross income of the agency, or one of a couple of formulas based on hours spent on their clients. Clients & Profits provides the opportunity to choose the allocation method that best reflects the way an agency uses overhead for the servicing their clients.
The AAAA guide dealing with overhead allocation is: The AAAA's Guide to Individual Client Profitability.
Q. What is the Overhead Allocation Worksheet?
The Overhead Allocation Worksheet is a G/L tool that calculates each client's share of the shop's overhead expenses and direct labor costs. The amounts on the worksheet are then reflected in the Client P&L Analysis when it's printed for the same period after the worksheet has been completed. It works by determining the total overhead expense amount for the period, then backing out the total direct labor (salary, bonus, etc.) expense per the worksheet, to arrive at a final overhead expense amount. The worksheet can distribute overhead expenses based on one of four formulas (see below), depending on how you want to allocate overhead to clients. The direct labor expense is allocated on a percentage basis per staffer, based on the number of billable hours each staff person spent on each client.
When using the worksheet, you'll first choose an overhead allocation method (they're described in detail below). Each of these four methods is listed by the AAAA in their "Guide to Individual Client Profitability". After choosing the allocation method, the worksheet will display all staffers that have billable hours for the selected period. You'll then be prompted to enter the individuals' monthly direct labor costs (i.e., salary, bonuses, benefits, etc.). Clients & Profits then calculates the amount of direct labor cost which should be allocated to each client. It does this by dividing the total salary for a staffer for a month by their billable hours for that month to derive an hourly cost. Then it applies this hourly cost based on the number of billable hours a staffer logged against each client. The remaining overhead amount (total overhead expenses, less total salary entered into the worksheet) is then allocated to each client based on the chosen method.
Q. What are the methods of overhead allocation?
There are four key methods for allocating overhead:
Agency Direct Service Costs
This method allocates the overhead dollars based on the actual hourly rate for each staffer for each month. It determines the total hours worked for each client from the staffers' time sheets, and then allocates these hours based on the salary for each staffer. This method is the most-used method by advertising agencies today. The method makes the assumption that there is a relationship between the salary of a person and the amount of overhead used by that person in a given month. Think of it as "weighting" the hours based on one's salary.
Agency Billings
This method allocates the overhead dollar amount based on the percentage of total billings each client generated that month.
Agency Income
This method allocates the overhead dollar amount based on the percentage of AGI (revenue less job costs) each client generated that month.
Agency Direct Client Hours
This method allocates the overhead dollar amount based on the number of total hours each client generated, without regard to the monthly direct service costs for the employees generating the hours. The hours spent on each client are not "weighted" based on the salary of the staffers spending time on the clients.
Q. What are included in labor costs?
These are costs which you determine are part of an employee's total cost to the shop. They will always include salary, bonuses, and employer payroll expenses. They may also include any of a number of direct employee related costs listed in various expense accounts. You have the flexibility to determine what is most reasonable for you and your shop.
Q. Will other users be able to view the monthly direct service cost information after I've enter it into the Overhead Allocation worksheet?
No. After you save the monthly service cost information for each staffer, these amounts are used to make the calculation to allocate salary and overhead, and only the allocated results per client are saved. The actual labor input amounts are not saved, so they can't be seen by other Clients & Profits users.
Q. Our salary information is the same from period to period, must I reenter the salary information to run the report for a different period?
No, you would not need to change the salary amounts in the overhead allocation if there were no changes from the last time you ran the overhead allocation. The salaries you last entered into the overhead allocation will be retained when you run the overhead allocation for another period. The salary amounts will be always default to the last salary amount you entered into the overhead allocation.
Q. Where does the Client P&L Analysis report derive its information?
This is the report for which you create the overhead allocation worksheet. They do hand in hand. The per client client allocation on the worksheet directly impacts this report. First, it calculates the revenues and job costs for each client (like the Client P&L report), establishing a gross margin per client. Second, under the Direct Labor column the direct labor costs per client from the Overhead Allocation worksheet is applied to each client. Third, the overhead per client from the worksheet is applied to each client. In conclusion, the gross margin amounts are pulled from the general ledger, but the direct labor and overhead allocation are pulled from the worksheet.
Q. What is the Client P&L Analysis?
The Client P&L Analysis is a report that will directly reconcile with the Income Statement for any period, separating revenue, job costs, salary & overhead on a client by client basis. Think of it as an income statement broken out by client. This report will sort by most to least profitable client so you can quickly see who is making you the most money. With this report you may discover a number of things that affect your financial business decisions. The client you thought was profitable is actually unprofitable because it uses too many expensive individuals to manage the client (why Agency Direct Service Costs method is most used, because it weights the hours by salary when applying overhead). The client who has a low margin is actually profitable since it can be effectively serviced with more cost-effective staff. Or, it could be there are not enough billings for certain clients, especially since several industry studies have concluded the reason most unprofitable accounts occur is due to the lack of income instead of the agency having excessive overhead. Since one of the most important pieces of information you can know as an agency manager is how profitable are your clients, you'll definitely want to use the Client P&L Analysis every month.
Q. How do I print the Client P&L Analysis?
First, you need to complete the Overhead Allocation worksheet located in the G/L Tools window. Choose Accounting > General Ledger, then Edit > G/L Tools. After the Overhead Allocation worksheet is saved, then you can print the Client P&L Analysis. Choose Snapshot > Financials and click on the Income Statement reports. Choose the same period as you did when creating the worksheet.
Q. Can I print the Client P&L Analysis before allocating overhead?
Yes, but the direct labor costs and overhead allocation columns on the report will be blank. This is essentially the same as printing the Client P&L, which will only show gross margin per client vs. total income per client (which is what you're looking for with the Client P&L Analysis).
Q. What is the difference between the Client P&L and the Client P&L Analysis reports?
The Client P&L report shows revenues less job costs by client (i.e., gross margin by client). The Client P&L Analysis goes a step further by applying salary and overhead costs to each client, in addition to job costs, to arrive at total income by client.
Q. What is the "direct expenses" column for?
This column is used to separate agency overhead expenses (such as agency travel) which can be assigned to a specific client. The amount is deducted from agency overhead before allocation. To "tag" an overhead expense to a particular client under the Direct Expenses column, make sure you add a client code to the journal entry. Double click the posted journal entry and add a job number, then hit tab, and it will fill in the client code. Direct expenses are optional, so it's fine if this column has no amounts.
Q. How is salary allocated to each client when printing the Client P&L Analysis?
Technically, this is done on the Overhead Allocation worksheet, then it's simply copied into the Client P&L Anysis report (which is why is essential to save the worksheet before printing this report). How the worksheet does this: First, an hourly cost is established for each staffer by dividing the salary for a staffer in the Overhead Allocation worksheet by their total billable hours for that month. Hours marked as unbillable and hours logged against clients marked as "in-house" are excluded when determining an hourly cost. Then it applies this hourly cost based on the number of billable hours this staffer logged against each client that month.
Q. How is the "overhead" dollar amount determined when printing the Client P&L Analysis?
The total of all salaries for each staffer in the Overhead Allocation worksheet is subtracted from the total of the Expenses, Other Expenses & Other Income on the Income Statement. This dollar amount is then applied to each client by one of the four methods of overhead allocation. Because it "backs into" the overhead amount like this, this ensures the total income on the income statement ties to the total income on the Client P&L Analysis.
Q. I make month end WIP entries to match my revenues and expenses. Should I continue doing this as normal?
Yes, you should, with one important change. You will need to prepare your WIP journal entry by client. Enter the amounts for each client, then double click on each line and enter the appropriate client code. If you don't do this, then the total gross margin for each client in the Clients P&L Analysis will not agree with the total gross margin on your Income Statement. This journal entry will show up in the Client P&L Analysis as client code "--" and named "unallocated income/costs/expenses". C&P is expecting all amounts in the revenue and job cost accounts to have client codes, so when they don't, it dumps these amounts into this client to make sure the totals on the report agree to the standard income statement. Keep in mind that Clients & Profits Pro and Enterprise editions can automatically accrue media costs when creating a media prebilling. This automatic accrual entry includes the client number, which is needed for the Client P&L Analysis.
Q. Does the Overhead Allocation Worksheet save for each period I save it so I can go back and print the Client P&L Analysis again?
Yes. The most recent overhead allocation worksheet for any given period is saved and will be used for the Client P&L Analysis, copying its amounts into the Direct Labor and Overhead Allocation columns of the Client P&L Analysis for that period.
Q. Can I print the Client P&L Analysis for a period using different overhead allocation methods?
Yes, but you'll need to re-enter the period's salary amounts in the worksheet and choose this method. As a practical matter, once you determine which allocation method makes the most sense for your shop, that's the only method you should run on an ongoing basis. To run multiple allocation methods for the same period would be confusing (as marginal accounts could switch from profitable to unprofitable) and would diminish the effectiveness of the analysis to monitor performance over time. The four allocation methods are there so you can make the determination of which one best represents the way overhead is used in your agency.
Q. I need to edit a staff member's salary information and reprint the Client P&L Analysis. How can I do this?over
In order to change the salary for one staffer and update the Client P&L Analysis you would need to run the Overhead Allocation Worksheet again with the change. Enter the change for the staff member' salary into the salaries portion of the Overhead Worksheet. Once you have run the worksheet again the Client P&L Analysis report will be updated for the change.
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