Out-Of-Pocket Expenses in the PR Industry

When considering client profitability and overall agency profitability, the recovery of out-of pocket expenses (OOP) can be a key factor for agency profitability. Under certain circumstances a mark-up on these expenses should be considered. Unfortunately, many agency principals tell me that they do not mark–up OOP expenses and more importantly,  do not understand the book and tax accounting rules for these expenses. Accordingly, this month I am discussing what you need to know about OOP.

Types of Expenses

The expense part of a client budget at a PR firm can add up to a significant sum of the overall client budget. As a result, agency clients will put these costs under a microscope. Properly supporting these costs to your client is important to avoid write-offs and low profitability.

There are two types of costs that an agency bills back to its clients: its own overhead expenses and expenses incurred on behalf of clients. Generally, the term “rebillables” has been used in the PR industry to describe expenses billed back to clients. I generally prefer to use the term “rebillables” for internal overhead expenses and “CPT” (client pass through) for expenses (really costs) incurred on behalf of clients.

Recovering Rebillables

Al Croft said it is always worth billing all reasonable expenses back to clients. Either track the exact costs (should be automated) or charge a percentage of the time to cover such costs. In my view, 6% or 7% of the time bill, added to each invoice to cover miscellaneous postage, copies, telephone costs, etc., seems fair. Larger costs such as mailings or copy runs should be billed separately.

Charging expenses back to clients adds cash directly to your bottom line. For example, how many copies do you make monthly? Only 2,000 copies per month charged to clients at 25 cents each puts $6,000 back into your pocket annually and helps pay for the copier and the maintenance contract.

There may be a question as to whether an item is an agency or client expense. For example, if you take a client to lunch, that seems to be an agency expense. However, if you take both a client and an editor to lunch, that is the client’s expense. Remember there is no such thing as a free lunch. The rule of thumb is: Anything you do or spend on behalf of the clients gets billed back.

Substantiation

One way to impress a client as well as the IRS is to show that the agency has strict record and receipt-keeping requirements. Generally your client will expect you to meet the IRS substantiation requirements.

In order for you or your client to deduct a business expense, it must be an “ordinary and necessary” business expense. These terms have been broadly defined to mean customary or usual, and appropriate or helpful. Thus, if it is reasonable in your business to entertain a reporter or other business people, you should pass the deductible test.

In order for your client to deduct, as an example, a meal expense that you are billing back, you need to provide the client all the supporting documentation that is required to deduct the meal. Remember, meals for the most part are only 50% tax deductible. Your goal is to make sure the client has all that is needed to deduct the cost of the meal or your client will push the expense back to you! Not only will you have a bad debt but will also absorb the 50% disallowance.

Third Party Service

Rick Gould, in his book, The Ultimate PR Agency Financial Management Handbook, wrote a section on third party services.

When your PR agency buys items or third-party services for a client, the traditional approach has been to bill them to the client separately as “OOP” expenses.

It is important to recognize that these expenses are not your revenue! For example, assume your agency fees for the year are $1 million. You need to hire a third party service provider for a client at a cost of $250,000. Your revenue for the year is not $1.0 million plus $250,000. The cost of the service provider is not your business expense deductible for tax purposes. It is merely a receivable from the client. If your agreement is to pay the service provider on behalf of the client, the cost is not tax deductible! It is a payment of a client liability — or an offsetting receivable and payable, not revenue and expense.

You may want to send two bills out each month. Once for fee earned and the other for expenses. Items representing CPT should be billed separately enclosing any necessary documentation.

Mark-up

Many agencies do not mark-up client expenses. This is a mistake. You are providing a service to the client and in some cases acting as a bank! Often, the agency’s direct OOP expense is increased by 17.65% (This has been a stand in the industry for as long as I can remember.) It represents, in addition to the dollar for dollar reimbursement, a fee to cover the time and series involved in obtaining the item or the third-party service billed. It is important that this provision be spelled out correctly in your client agreement and be reviewed with your legal counsel. If a client does not want to pay the mark-up, consider having the client directly negotiate the terms of the third party service provider and have all bills go directly to the client for payment.

Caution

When you bill back a client expense or an overhead expense, there could be sales tax issues. For example, the state can take the view that the mark-up is not really a fee but an additional cost of the item. If that is the case, the mark-up itself can be subject to sales tax. You need to discuss this issue with your own CPA and/or lawyer. If this can be an issue, you may want to label the mark-up as an administrative fee. Again, get the proper advice before acting.

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