You have established a successful agency focusing on permanent recruitment and you have now started to branch out to establish an on-hire book.
A contracting book is often considered more valuable than a permanent book due to the continuing nature of the income. It is known in the industry that agencies that have a successful contracting book will normally be less susceptible to cyclical fluctuations caused by economic factors and, should the owner ever sell the business, the contracting book will be considered more valuable than the permanent book.
A consultant that has a mature contracting book will not have the lumpiness of commissions that result from permanent placements. Commissions are smoothed out over the period of the contractor’s term. As such, a consultant with a contractor book can still get paid a commission whilst they go on leave. It may pay less commission upfront than permanent placements, but it can be as lucrative over a period. In addition, on-hired workers can be relocated to new clients once their term expires so they can be a source of revenue for years.
In most cases, the administration and accounting for contractors compared with permanent placements is vastly different. For the majority of contractors placed, the agency needs to account for the worker as if they were an employee of the agency with the added administrative burden of processing contractor timesheets.
With all this in mind, we have created a guide designed for agencies (between three and seven years old) transitioning from a permanent placement business to a combination of permanent and on-hire.
Here are our eight essential issues for any agency transitioning from a predominately permanent book to a combination of a permanent and contracting book. They are fundamental to start, however, you should not consider this a complete guide. Please speak to your financial adviser to ensure you appropriately cover off everything.
1. Accounting systems / Payroll Systems
It is assumed your accounting system and financial reporting function are operating effectively. This is imperative prior to an agency taking on contractors. General, most agencies will use Xero.
You will be required to process contractor timesheets and make payments using the contractor’s pay rate. Pay cycles will vary depending on the industry, however generally payments are made weekly or fortnightly. You may need to consider industry awards should these apply to contractors. This can be tricky and will require someone with experience to assist you.
Remember you will need to process invoices to clients using the contractor hours and agreed pay rate. Invoicing is generally weekly or monthly.
Initially, you may use accounting software to process your payments however as your contractor book grows you will need a payroll/billing system that provides for greater efficiency. Generally, this happens once you have approximately 20 contractors. A payroll/billing system can provide the following:
- allows your contractors to enter their own timesheets;
- creates Recipient Created Tax Invoices (see below) where relevant;
- cross check pay rates, including awards if applicable;
- the system will directly make payments to contractors;
- invoicing of client using hours obtained from timesheets and agreed pay rates;
- interfacing to your accounting system.
A payroll/billing system will mean less errors and reduced staff processing time.
The exception would be for “margin only” arrangements with clients. These arrangements mean that agencies just invoice the margin and the contractor is effectively employed by the client. It is akin to a commission. These arrangements are less prevalent and, in most cases, yield less margin.
2. Managed Payroll Providers
The payrolling of contractors can be outsourced to a third party who manages the contractor’s payroll, tax, workers compensation and superannuation on your behalf. The provider will normally have a portal (branded as your agency) that allows contractors to enter timesheets. The provider will charge a percentage of contractors pay or a set amount per contractor.
3. Taxation issues and superannuation
The taxation issues associated with contractors must be considered and understood as there are many variations to the way contractors can structure themselves. The below table provides the most common contractor structures and the recruitment agency’s associated taxation and workers compensation obligations:
|Method of payment
|Workers Comp. Payable
|Treated similarly to an employee
|Treated similarly to an employee
|Recipient Created Tax Invoices
|Recipient Created Tax Invoices
|Managed Payroll Operator
|Recipient Created Tax Invoices
1 – Responsibility of the company
2 – Responsibility of the Trust
3 – Responsibility of the managed payroll provider
4 – Depends on the provider
This is high level and there may be exceptions to the above.
4. What insurance will you need?
Firstly, you will be required to take out workers compensation for all contractors based on the above table. Although you will not be required to take out insurance to cover contractors that are structured as companies or trusts, you will still be responsible to ensure they have adequate up-to-date cover.
Secondly, you will also be required to take out professional indemnity insurance. This covers the legal liability to compensate third parties who sustain financial loss due to a breach or alleged breach of professional duty on the part of the agency, your employees or your contractors.
Thirdly, it will also be necessary to take out public & products liability. This covers the legal liability to pay compensation to third parties in the event of the agency causing or being alleged to have caused injury, death or loss of or damage to property arising out of its business operations.
5. Cash flow / debtor finance
One of the most stressful aspects of running a contracting business is ensuring your working capital requirements are adequate and your cash-flow is under control. This can be a consequence of having to make payments to contractors on a weekly basis but having your debtors on 30 plus day terms. You may find that despite the fact you limit the amount of cash you take from the business you may start to run short of cash.
As contracting businesses grow, it is common for owners to take out debtor finance in order to manage their weekly working capital requirements. Generally, it involves the provision of finance from a banking institution that is secured by the debtor book. The way it works is outlined below:
- invoices that have been generated are sent to your client and a list of these invoices are on-sent sent to the bank;
- subject to certain restrictions, the bank will immediately make funds available equating to a defined percentage of the value of the approved invoices. Generally, this can be 75% to 85% of the value of the invoice;
- the debtor will then make payment of the invoice to a dedicated bank account in the recruitment agency’s name. At that time, the remaining percentage (ie 15% to 25%) of the invoice value will be paid to the recruitment agency.
Certain facilities restrict what invoices will be accepted for finance. This may include limiting the finance available for invoices relating to permanent placements or specific debtors.
When determining the actual cost of the facility, you will need to consider both the interest cost and all associated fees. This will provide you with an effective rate. Depending on your finance provider, the way they charge will vary. The two most common methods are:
- fixed rate based on a minimum amount of expected debtors; or,
- fees split into the following:
- invoice acceptance fee – this is a fee payable once invoices are uploaded to the bank. Essentially it is a fee for making the finance available.
- interest rate – this is payable based on the how much is drawn down from the facility.
Effective rates can vary from approximately 6% to over 10%. When comparing finance providers owners must ensure they are comparing “like for like’ products. It is the effective rate that owners need to compare. This includes all associated fees.
6. Price setting
Calculating the correct rate to charge out contractors is crucial for a successful contracting business. There have been many examples of agencies that have set contractor rates too low and consequently made losses on clients all because they did not take the time to price set accurately. Winning a client at all costs is a dangerous strategy and higher revenue does not always equate to higher profit.
Price setting is the process of taking the hourly rate paid to the contractor and determining the minimum hourly price that contractor can be charged out to client. The difference between the two numbers is the margin. The margin divided by the hourly client price is the margin percentage. The margin percentage is a factor of supply and demand. For example, if your agency provides specialised white-collar contractors that are in high demand the margin percentage will be higher than blue collar contractors that are readily available at numerous agencies.
Price setting can be a tricky process as it requires the forecasting of revenue and expenses.
7. The legal requirements you need to know
You will need contracts drafted for your contractors that protect your agency and the contractor These include:
- the term of the arrangement;
- early termination;
- ensuring the client understands when payment is due;
- fees associated with contractors that are offered permanent roles;
- the contractor’s safety; the charging of any disbursements incurred.
8. Labour hire licensing
Some states in Australia, for example in Victoria and QLD, require that in order to supply labour hire services you must have the appropriate labour hire license. The applications can be tricky or complex and as such it is advised to seek the assistance from others (e.g. your accountant) if needed.
If you require assistance with starting up your recruitment agency, get in touch with Sovereign Private on 02 9227 9000 or at firstname.lastname@example.org.