Advertising agencies, regardless of the contractual definition of their role (agent vs. independent contractor), act on an advertiser’s behalf to procure and pay for services, space, time, etc… purchased from third-party vendor organizations that are related to producing and distributing the client’s advertising and communications messaging. In turn, the advertiser is billed by the agency, typically upfront on an “estimated” basis for those goods and services with payment due to the agency in 15 to 30 days from receipt of invoice. Terms between agency and client are usually set to insure that the agency has the client’s funds prior to the time third-party vendor invoices are presented for payment.
For most advertisers, there is little transparency into the financial transactions between their advertising agencies and their third-party vendors, which number in the hundreds, if not thousands. This lack of transparency results in diminished advertiser control and increased risks associated with third-party vendor reconciliation and accounts payable management. Risks typically fall into four areas:
- Clear and unambiguous title to any and all intellectual property/ work product
- The advertiser’s reputation among 3rd party vendors
- Treasury management “opportunity” costs
- Exposure in the case an agency became unable to pay its creditors
AARM conducts agency contract compliance and financial audits of advertising and marketing agencies on behalf of advertisers. In our experience it is rare to see a client-agency contract that identifies clear terms and conditions for the agency’s handling of third-party vendors or in establishing processes and controls to allow the advertiser to monitor performance in this area. Don’t advertisers want to know if and when third-party vendors have been paid? If vendors were paid at the agreed upon rate or something less? If the reconciliation process resulted in credits, discounts or rebates that are due back to the advertiser? Who are the vendors being utilized?
Based on our financial audit experience, there has been a clear trend in recent years of agencies stretching out disbursements to third-party vendors well beyond their payment terms, as measured by “Days Payable Outstanding” or the time lag from vendor invoicing to agency payment to the vendor. There can only be two reasons for this performance and neither is particularly sound. Firstly, the agency may have flawed vendor reconciliation processes and or they are putting inadequate resources against this “non-revenue generating” area of their business. Secondly, the agency is seeking to maximize interest income from float. Simply defined, “float” is the amount of money that the agency has collected from the advertiser but has not yet disbursed to a vendor. In almost all instances, agencies both earn and retain the interest income on this float.
Within the agency community it is often joked that interest income (from float) is an agency’s best client; “It pays on time and never complains.” However, when it comes to the advertiser’s reputation the risk of being labeled a “slow pay” is no laughing matter. Whether deserved or not, such a reputation can carry both opportunity costs and economic costs in the form of vendors charging higher rates to compensate for their “carrying costs” or not offering preferential treatment. Nor do many client-side CFO’s find much humor in lost interest income opportunities, aged vendor credits or delayed earned but unprocessed discounts and rebates.
When the size of an advertiser’s budget is considered and the fact that this investment is being managed through a small group of agencies, who in turn handle purchases and payments on behalf of the advertiser with hundreds of diverse third-party vendors ranging from media property owners to production studios to third-party ad-servers, it may be time to perform an independent assessment of performance in this important area.
After all, we’re all familiar with the adage: “What is inspected is respected.”
Interested in learning more about the financial portion of an agency contract compliance audit? Please contact Don Parsons, Principal at AARM at email@example.com for a complimentary consultation.