Like most people, I was drawn into the world of advertising agencies because, for a lack of a better word, they are just plain cool. When we think of advertising agencies, the first images that may pop into our heads are creative commercials, billboard ads or maybe even those annoying pop up ads on our free phone apps. For others, it is the image of the mysterious but extremely talented Don Draper from Mad Men.
One thing that probably doesn’t quickly come to mind is the various quirks and complexities that come with ad agencies from an operational and accounting perspective. As exciting as it is to be involved in the world of advertising, many people quickly find themselves in a whirlwind of confusion at the end of each quarter when they take a look at their financials and ask themselves, “Why don’t my financials make any sense?” Unlike most other industries, there can be a significant time lag between when the agencies will incur costs (whether it be media buys or the cost to produce an ad campaign), the time the advertisements are released via print, TV and radio, and the timing of when the agencies are paid by their customers. In fact, many times the order of these occurrences can happen at different times for different advertising campaigns to make things even more exciting.
The problem that so many companies have is that they book only their expenses in the period that cash is spent, which produces the most dismal of results: all costs, no revenues. Later, after the cash comes in, they will record their revenues, which result in the best months that they ever had as there are no expenses to offset the revenues. Fortunately there is an easy solution to this problem, which has everything to do with revenue recognition. Per the rules of the almighty Financial Accounting Standards Board (FASB), revenues must be recorded when earned (not just when cash is collected), and the earning process is considered complete when the agency has performed all of their obligations per their customer contract or project estimate. In most cases, the revenue process is complete once all of the expenses (e.g., purchased air time, production costs) are incurred and the final project is produced. In situations where customer cash is received in advance, such cash should be deferred and booked in the balance sheet as an advanced billing or unearned revenue, which will then be depleted as such revenues are earned. In other situations where the work is performed in advance of payment, a receivable must be booked. In much simpler terms, the revenues must be matched with their expenses in the period in that the agreed upon services have been fulfilled.
As you can see, without recognizing revenues and expenses in the proper period, there can be a very adverse impact to your financial statements and your bottom line. As an owner, CFO or any other user of financial data, it is crucial to understand exactly how your agency is performing. However, without solid meaningful data, this can be virtually impossible. Although the next quarter or fiscal year end may seem far in the future, understanding the revenue recognition standards today will allow your company to be better prepared to make important management decisions in the present and future.