Agency margin explained (without accounting jargon)

Agencies are simple on paper: you sell outcomes, and you deliver them with people. In reality, margin gets tricky because most agency costs are semi‑fixed (salaries, leadership time, tools) while revenue is often lumpy. That’s why two agencies can have the same revenue but wildly different profits.

This calculator uses a practical structure you can map to most profit & loss statements. It separates costs into direct delivery costs (what it takes to fulfill the work) and operating expenses (what it takes to run and grow the agency). The two big outputs are:

• Gross margin = (Revenue − Direct delivery costs) ÷ Revenue. This tells you whether your delivery engine is priced correctly. If gross margin is low, you’re either underpriced, overstaffed, underutilized, or heavily dependent on contractors.
• Net profit margin = (Revenue − Direct delivery costs − Operating expenses) ÷ Revenue. This is “real profit” after overhead and marketing. This is the number investors and buyers care about most.

There’s also a reality check most agencies skip: utilization. Utilization converts headcount into revenue. If you have five delivery people, that doesn’t mean you have five fully billable people. You have internal meetings, scope creep, training, admin tasks, and the inevitable “project transitions.” Utilization captures that.

If you pick Estimate revenue from team capacity, we compute base service revenue like this:

• Billable hours per month = Team size × Hours per person × Utilization%.
• Service revenue = Billable hours per month × Avg billable rate.

If you already know your monthly revenue, choose the direct revenue mode and simply enter it. In both cases you can add “Other monthly revenue” (projects, audits, workshops, upsells).

Pass‑through costs are expenses you pay on a client’s behalf: ad spend, printing, event costs, stock photos, etc. Many agencies bill these at cost (or with a small markup). If you include pass‑through in revenue and costs, it can make margins look artificially low (because it inflates both sides without adding much value).

That’s why the default setting is to exclude pass‑through from margins — it gives you a cleaner view of service profitability. If you earn a markup or management fee on the spend, you can either: (1) include pass‑through and raise your revenue slightly for the markup, or (2) keep pass‑through excluded and add the markup as “Other monthly revenue.” Both are defensible; the goal is consistency.

• Payroll: Salaries, wages, and payroll taxes for anyone who spends meaningful time delivering or managing delivery. Many agencies include leadership payroll here too (because it’s required to ship the work).
• Contractors: Freelancers and specialized vendors needed to fulfill client work.
• Delivery tools: Project management, design software, analytics tools, QA tools, hosting that’s tied to delivery.

• Overhead: Rent, admin staff, accounting, legal, insurance, office services, non‑delivery software.
• Sales & marketing: Ads, outbound tools, commissions, events, content, partnerships, sponsorships.

Margin becomes actionable when you can pull a lever. This tool intentionally shows both the raw numbers (profit dollars) and the ratios (margins), so you can decide whether the better move is to increase revenue, reduce cost, or reshape how you deliver.

The exact formulas this calculator uses

• Capacity mode:
  Billable Hours = Team Size × Hours per Person × (Utilization ÷ 100)
  Base Revenue = Billable Hours × Avg Billable Rate
  Total Revenue = Base Revenue + Other Revenue
• Direct mode:
  Total Revenue = Monthly Revenue + Other Revenue
• Pass-through treatment:
  If “Include,” then Total Revenue += Pass-through and Total Costs += Pass-through (it cancels out, but changes margins). If “Exclude,” pass-through is ignored for margin math (recommended).

• Direct Costs = Payroll + Contractors + Delivery Tools
• Gross Profit = Total Revenue − Direct Costs
• Gross Margin % = (Gross Profit ÷ Total Revenue) × 100

• Overhead = (Overhead % × Total Revenue) if percent mode, else fixed overhead.
• Sales & Marketing = (Sales & Marketing % × Total Revenue)
• Operating Expenses = Overhead + Sales & Marketing

• Net Profit = Total Revenue − Direct Costs − Operating Expenses
• Net Margin % = (Net Profit ÷ Total Revenue) × 100

The target slider doesn’t change your math — it changes your recommendations. If you want 20% net margin, the tool will tell you whether your current economics hit it, and if not, the simplest path to get there (usually a rate increase, utilization improvement, or cost reduction).

Three realistic scenarios (and what to do next)

Numbers become useful when you can see the story. Here are three examples you can recreate by moving the sliders. (All examples assume pass‑through is excluded.)

Imagine a small agency with 5 delivery people, 160 hours/month each, 65% utilization, and a $150/hr blended rate. That’s roughly 5 × 160 × 0.65 = 520 billable hours, and 520 × $150 ≈ $78,000/month in service revenue. If payroll is $35k, contractors $5k, tools $1.2k, overhead 12% ($9.4k), and marketing 8% ($6.2k), then net profit is around $78k − ($41.2k direct) − ($15.6k opex) ≈ $21.2k. Net margin ≈ 27%.

That’s solid. Now watch what happens if utilization drops to 50% (projects are choppy). Billable hours fall to 400, revenue becomes $60k, but payroll doesn’t fall. Net margin can collapse quickly. The lesson: when payroll is fixed, utilization is the fastest lever in the system.

Same team, same utilization — but the average billable rate is $110/hr. Revenue drops to about $57,200/month. Costs barely change. If your net margin drops into single digits, you’re not “bad at business” — you’re priced for survival. The fix is rarely “work harder.” It’s usually:

• Increase rates for new clients (start with +10–20%).
• Productize a core offer (same delivery, higher perceived value).
• Stop discounting with “extra hours.” Extra hours are unbilled costs.

Suppose you run paid ads for clients and you process $50k/month in ad spend. If you include pass‑through in revenue and costs, your “revenue” might show as $120k while your direct costs include the $50k pass‑through. If you don’t earn a markup, gross margin % looks lower even though service economics are unchanged.

In that case, exclude pass‑through to understand service profitability — then add a management fee or markup if you want to make that workflow meaningfully profitable.

Frequently Asked Questions

• What’s the difference between gross margin and net margin for an agency?

  Gross margin focuses on delivery efficiency: revenue minus delivery costs (people/contractors/tools). Net margin includes overhead and sales/marketing, which reflects true profitability.

• Should payroll be “direct cost” or “overhead”?

  Different agencies classify it differently. This calculator treats payroll as direct cost because payroll is the main delivery input. If you prefer, you can move part of leadership/admin pay into overhead by lowering payroll and raising overhead. The totals matter more than the label.

• What utilization should I aim for?

  Many agencies target 60–75% billable time for delivery teams. Higher can boost margins short term but can increase burnout and reduce quality. Sustainable operations often beat maxed-out utilization.

• What’s a “good” net margin?

  10–20% is common for stable agencies. 20–30% is strong. 30%+ typically means you’ve productized, have pricing power, or have very efficient operations. Context matters: growth-focused agencies might reinvest profits into marketing and hiring.

• Why do my margins change when I include pass-through costs?

  Because the denominator (revenue) and numerator (profit) behave differently. Pass-through often adds revenue without adding profit. Excluding it gives a clearer picture of service margins. Including it is only meaningful if you earn a markup or fee.

• How can I increase net margin fastest?

  In most agencies, the fastest levers are: (1) raise rates for new work, (2) improve utilization by tightening scope and reducing unbillable meetings, and (3) reduce contractor dependency by reusing templates/processes. This calculator’s “Next steps” highlights the simplest move based on your numbers.

Make this viral (and useful)

Agency owners share margin calculators because they create a “whoa” moment: you change one slider and the whole business model shifts. This page is tuned for that:

• Utilization slider shows how “being busy” can still be unprofitable.
• Blended rate slider shows pricing power in seconds.
• Target net margin turns the output into a goal with recommendations.
• Share buttons let users post their snapshot (no private numbers required — it shares margin % only).

If you want to make it even more shareable, add a “hide $ amounts” toggle later. For now, the shared text avoids sharing dollar amounts by default.