5 Expenses
Whether you are running a neighborhood lemonade stand or a major media corporation, it takes money to make money for most business ventures. The lemonade retailer needs to pay for lemons, sugar, glasses, and a table before the first customer strolls by. Similarly, a broadcast station or cable system needs to acquire all types of program content before the first audience member or potential subscriber will pay attention. After addressing the issues of revenue in Chapter 4, the same three authors now look at the “other side of the coin,” and address the necessary information needed to monitor—and, more importantly, control—business expenses.
Introduction
Operational expenses are recognized on an accrual basis (not on a cash basis), and consequently expenses should be “matched” to the appropriate revenue and time period. In broadcast and cable, the expenses include variable expenses (such as sales commissions and programming fees), as well as fixed expenses (such as salaries and benefits, maintenance, marketing, IT, leases, and utilities). Radio stations typically enjoy a higher operating margin (operating income divided by net sales) than other broadcasting or cable entities due to low fixed costs and lower variable costs associated with revenue. Large-market VHF television stations (stations operating on channels 2–13) can also exhibit high levels of profitability because they can command more dollars from advertisers, whereas both their fixed and variable costs represent a lesser percentage of sales than do those of their smaller-market brethren.
In any case, expenses associated with broadcasting can vary dramatically depending on such factors as the cost of programming, market size, radio station format, and geographic location. However, most media operations experience the same type of expenses. These cost centers typically are organized into departments, such as Sales, News & Programming, Marketing & Promotions, Technical & Engineering, Information/Interactive Technology (IT), and General & Administrative (G&A).
Expenses common to all departments and not easily broken out or identified among departments are often combined within the G&A category. As outlined below, these expenses include employer-paid taxes—such as FICA (Federal Insurance Contributions Act, which includes Medicare and Social Security), FUTA (Federal Unemployment Tax Act), and SUI (state unemployment insurance)—as well as employee benefits, such as medical, dental, long- and short-term disability, workers’ compensation, and life insurance. Other benefits common to company employees are vacation pay and employer contributions to 401(k) plans. Office and other supplies also fall into this category of common expenses that are not easily differentiated among departments; however, some companies insist that the individual departments should be accountable for these work-related expenses.
The reporting of trade expenses also varies significantly among companies. Some operations elect to have trade expensed by category or department based on the usage. Others prefer to compile all trade into single revenue and expense accounts. In some cases, both trade revenue and expense are separated from other revenues and expenses and are shown in a separate area of the financial statement. In other cases, companies choose to exclude trade expenses from the profit and loss statement. Trade expenses are not included in the calculation of cash flow.
Many broadcasting companies operate several stations in a single market, and many cable operators serve several community franchises in a single market. These groupings are referred to as “clusters.” Thought should be given to the allocation methodology of shared expenses such as salaries for General & Administrative Department staff or office rent. Some companies allocate these costs as an equal percentage distributed over all stations/systems. Other expenses, such as salaries and bonuses for the sales manager and support staff, may be allocated to each station/system/network based on its revenue as a percentage of total market/product revenue. Other companies want to see how much each individual entity contributes to net profit, and thus allocate only station/system/network-specific revenues to the individual entity. In this case, shared expenses are charged to an account that is not entity-specific. This gives companies the ability to easily separate station/system/network finances in the event there is a sale of some, but not all, of the pieces of a local cluster or business. There is no correct or incorrect approach to financial allocation, but consistently applying the same methodology is important in order to track and identify cost trends and analysis.
Typical Expenses
A discussion of typical expenses and their associated department classifications follows. Although companies may have different philosophies about the classification of some expenses, these expense classifications are typically standardized within an individual company.
Sales Expenses
These are expenses directly related to the generation of revenue for the operation. All things being equal, the cost of sales as a percentage of revenue should decline year-over-year because commissions and other expenses related to renewals are lower than those for new business. In reality, external events such as format changes and product additions keep this from happening. Costs typically included in sales are:
• Added-value expense and merchandising. These are expenses associated with a particular sales package or client advertising expenditures, and sometimes include trips and event tickets. Most companies cap this type of expense at 2 percent of the advertising revenue derived from any individual client.
• Bonuses for management and account executives, typically based on achieving predetermined revenue levels or revenue share of market goals.
• Internet sales expense, including third-party costs to outside sellers.
• Meals and entertainment for clients.
• Fees paid to national rep firms.
• Outside-collection expense for accounts written off to bad debt.
• Ratings expense for third-party vendors that track the size and demographic composition of audiences, including payments to research companies such as Arbitron, Nielsen, and Eastland. Some companies attribute this expense to the News/Programming Department because programming is directly related to audience ratings performance. As new tools of audience measurement emerge, one can expect this expense to continue to increase accordingly.
• Recruiting and moving expenses for sales staff.
• Revenue-monitoring services. These services track overall competitive market revenue, segmented by advertiser and by station.
• Sales-commission expense, including management overrides (this commission paid to sales managers for sales made by the local sales staff typically varies with sales revenues), and sales guarantees (a minimum guarantee of wages for a specific period, typically based on a fixed or sliding scale).
• Sales commissions consist of two common types of policies: payment on billing or payment on collections. Both policies yield the same expense for income statement purposes; however, payment on collections creates a liability that is relieved over time as clients eventually pay their bills.
• Sales-management salaries, including director of sales and local and national sales managers.
• Marketing materials for the Sales Department.
• Support staff for the Sales Department, such as secretaries and administrative assistants.
• Severance and termination costs related to sales employees.
• Software expenses, such as demographic data, inventory and rate-management systems, and client database software.
• Third-party commissions, including Internet sales or other sales organizations.
• Training expense.
• Travel reimbursement, including mileage and out-of-town expenses.
News & Programming Expenses
The largest expenses in operating a radio or TV station typically involve news and programming. These are the costs required to produce or acquire programming, which includes the cost of labor. For example, in radio, a locally produced news/talk format typically requires many personnel, and hence has higher costs. Conversely, acquiring the rights to a nationally syndicated program can be very cost effective. The same is true for television stations, depending on the popularity of the program and available audiences. Sports programming typically requires rights fees, which can be extremely burdensome. Costs typically included in the News & Programming Department include:
• Bonuses for on-air staff and other news and programming personnel. Bonuses typically are based on achieving ratings or ranking goals for the targeted demographics of the station, and can equal or even exceed the base compensation.
• Dues and subscriptions for trade magazines and news publications.
• Fees paid for music, news, shows, or production material produced by a third party.
• Music license fees are a significant area of expense, and include payments to BMI (Broadcast Music, Inc.), ASCAP (American Society of Composers, Authors and Publishers), and SESAC. Recent negotiations of industry license agreements have made this a fixed cost (as opposed to a variable cost based on revenue achievement) for television and radio stations. More on music license fees is addressed in Chapter 14.
• News and local traffic services.
• On-air giveaways. Stations, in particular, attract listeners with contest prizes; these may include cash giveaways, merchandise, and/or trips. Some stations expense these items in the Marketing & Promotions Department.
• Other outside services. These can include programming consultant fees or voice talent by people other than station employees.
• Production and recording materials.
• Programming research. Research is performed periodically to keep a pulse on the popularity of the station as a whole, or on individual elements of the station’s programming, such as the music or talent. The type and frequency of research studies can vary depending on the type of program content provided by a station.
• Salaries for operations manager, program director, on-air and news talent, and production staff. Other, more-format-specific positions include news writers and reporters for a news/talk situation; a sports station will employ sports reporters. Many of the news and programming employees are under contract with the station, and may be parties to noncompete agreements. Salaries for on-air talent often vary by format and day part, as well as market location. For example, in radio, a morning show personality probably will command a greater salary than that for evening or overnight talent, and a Top 40 station personality may command a greater salary than a personality at an easy listening station.
• Severance and termination costs related to news and programming employees.
• Software fees related to scheduling music or programming.
• Sports rights fees.
• Syndicated programming. After a rash of ownership consolidation in the 1990s, many companies tried to reduce their expenses associated with operations in many of their smaller markets. Because talent costs are among a station’s largest expenses, some companies have chosen to syndicate popular talent across many stations.
• Talent fees for other station work, including remote broadcasts and appearances. Employers are liable for payroll taxes associated with additional compensation employees receive when they are representing the company at events of this type. Policies should be in place to ensure that payments for these appearances are made through the Payroll Department, and not directly from advertisers. Talent-fee revenue billed to clients offsets talent-fee expense.
• Training and travel expenses associated with industry events.
Cable Network Programming Expenses
Typical expenses specific to a cable programming network include:
• Amortization expense for internally developed programming (these costs are normally capitalized and amortized over the life of the program).
• Amortization expense for licensed shows aired (these costs are normally capitalized and amortized over the life of the contract).
• Consulting fees to outside talent or research-and-development initiatives.
• Launch support fees. These are payments made by the cable programmer to the operator to help launch and promote the new channel on the local system. Launch support is not always offered; when it is, the support is amortized monthly over the length of the contract. As explained in Chapter 4, launch support is a contra revenue account. These fees are normally capitalized and amortized over the contractual term of the applicable distribution agreements as a reduction in subscriber-fees revenue. If the amortization expense exceeds the revenue recognized on a per-distribution basis, the excess amortization is included as a component of cost of service. This situation occurs when a network is attempting to increase the subscriber base, and justifies the higher cost of launch support by increasing revenues from advertising to pay for the growth.
• Music license fees.
• Salaries for the Programming Department.
• Talent fees for other network work, including remote broadcasts and appearances. Employers are liable for payroll taxes associated with additional compensation employees receive when they are representing the company at events of this type. Policies should be in place to ensure that payments for these appearances are made through the Payroll Department, and not directly from advertisers. Talent-fee revenue billed to clients offsets talent-fee expense.
• Training and travel expenses associated with industry events.
Programming costs include in-house, original programming, as well as programming acquired from outside syndicators. The costs of original programming are capitalized (that is, they are treated as capital assets) and amortized over their estimated useful life. The various methods of amortizing these costs are: (a) the straight-line method, in which the same amount is written off for each period during the estimated useful life; (b) based on the number of expected showings; and (c) the accelerated method, in which proportionately larger amounts are written off in earlier periods of the asset’s expected useful life (see discussion of “conservatism” in Chapter 3). The costs of acquired programming represent amounts paid or payable to program suppliers for the limited rights to broadcast programming. Exhibition rights under the licenses are generally limited to the contract period or a specific number of showings or runs.
As explained in Chapter 3 under Conservatism, original and acquired programming costs are stated at the lower of cost less accumulated amortization or estimated net realizable value. The programming inventory must be reviewed at year-end to ensure that the value on the books reflects the potential revenue that is going to be generated from each programming asset. If the potential revenue is lower than the value of the program in the books, then a write-down needs to be recorded.
Cable System/Operator Programming Expenses
Expenses specific to cable systems include:
• Launch support fees—As explained in Chapter 4, from the perspective of a cable operator, the accounting for launch support fees is the mirror image of what is done for networks (see above). Cash is paid by the programmer, either up front or as the launch is achieved, and is recognized as deferred revenue (subject to normal current-versus-noncurrent considerations). Such credits are amortized (usually straight-line amortization) over the term of the contract as a “contra,” or reduction of programming expense.
• Video-product expenses—These are paid monthly to the network programming source, and are calculated on a rate per subscriber. These are determined based on contractual arrangements, and are a function of a number of variables including type of programming offered (e.g., sports vs. religious programming), the size of the operator, length of the contract, and channel position. Additional terms may include volume discounts, limited basic carriage requirements, and system penetration and tiering incentives. (For more information, see Cable System-Specific Revenue Streams in Chapter 4.)
• Retransmission consent—Historically, over-the-air local television broadcasters were carried on cable lineups based on “must-carry” provisions established by the Federal Communications Commission (FCC). In 1994, the FCC gave stations a choice of being carried under the must-carry rules or under a new regulation requiring cable companies to obtain retransmission consent before carrying a broadcast signal. If a local broadcaster opts for retransmission consent, an agreement is negotiated between the station (or the station’s affiliated network) and the cable provider. For many years, this has not been a cash transaction, but rather, an exchange of copyrighted program content for market distribution via cable. As of this writing, transactions increasingly involve cash payments.
Marketing & Promotional Expenses
Whereas Sales Department expenses focus on marketing to advertising clients, Marketing and Promotional Department expenses are those marketing costs that focus on capturing audience share.
• Advertising expense, including billboards, bus boards, TV spots, direct mail, radio, and Internet advertising. Because these expenses are typically very high, advertising expenses need to be evaluated carefully based on return on investment, which should include an analysis of how these costs impact ratings.
• Event expenses are those costs related to major events, concerts, and revenue-driven shows. Some companies include this expense in the Sales Department because it directly contributes to the revenue of the station/system/network. It is important to track these expenses by specific event, and to perform a financial analysis of an event’s profitability to determine the likelihood of repeating it in the future.
• Other promotional expenses include those related to remote talent appearances, including the cost for banners, tents, and other items used for the appearance.
• Premium items such as T-shirts, banners, key chains, and other small items given away on-air and at station appearances.
• Promotional software, including prizewinner databases.
• Salaries for the marketing director, promotions personnel, and street team.
• Station vehicle expenses.
Technical & Engineering Expenses
The Technical Department is charged with keeping the station, cable network or cable system operating, and in particular, the station studios, production facilities, headends, and transmitters.
• Contract payments for third-party engineers, technicians, and consultants.
• Circuit fees for contract transmission to tower sites.
• Power and other utility expenses at transmitter sites.
• Repairs and maintenance expense for studio and transmission equipment that should not be capitalized. These can be large expense items.
• Rents at the transmitter sites.
• Salaries for engineers and technical staff.
• Supplies and custodial property.
• Vehicle expenses for engineers and technicians, including mileage or gas and maintenance on station engineering vehicles.
Information/Interactive Technology Expenses
As discussed earlier, emerging revenue areas present new areas of expense. If a station streams its signal via the Internet, there are significant rights fees to be paid for this additional “broadcast” of music and commercials. These expenses may fall into different departments, depending on the views of corporate and station management. However, all stations within a company should be consistent in reporting expenses in designated departments. Specific items included here are:
• Computer hardware and supplies.
• Internet connection fees.
• Music copyright fees.
• Salaries for webmaster or IT personnel.
• Streaming fees.
• Talent fees.
• Web-hosting fees.
General & Administrative Expenses
The General & Administrative Department includes all of the standard expenses of running the business end of a property; this category usually includes compensation to senior management and the finance functions. Other items typically included in this category are:
• Bad debt expense for uncollectible accounts receivable. Some companies expense bad debt in the Sales Department as a cost of sales. A predetermined percentage of net revenue is used as the calculation to allow for uncollectible accounts. This percentage used is based on the collection history of a particular station, and may vary from station to station within the same company and the same market. The reserve account should be reviewed periodically (at least annually) to determine its adequacy to cover potentially uncollectible accounts.
• Banking fees, including credit-card and scanning fees.
• Bonuses for senior management and finance personnel.
• Charitable donations.
• Dues and subscriptions.
• Employer-paid benefits.
• Employer payroll taxes associated with department payroll costs, including FICA, FUTA, and SUI.
• FCC registration fees, which are determined and billed annually by the Federal Communications Commission.
• Franchise fees, which are payments made by a local cable operator to the local franchising authority.
• General Manager compensation (some operations have both variable and fixed component to GM compensation).
• Insurance such as property/casualty, general liability, directors’ and officers’ liability (D&O), and broadcasters’ liability.
• Legal and other professional fees.
• Meals and entertainment.
• Office-equipment rental.
• Office supplies.
• Other taxes, such as property, real estate, and local business taxes.
• Postage and freight.
• Printing costs, such as letterhead, business cards, and forms.
• Salaries for traffic, accounting, business office, and support staff.
• Software license fees for business systems, including general ledger, traffic, subscriber billing, workforce management, and accounts receivable.
• Studio- and office-lease expense should be amortized using the straight-line method for the life of the lease.
• Telephone expenses, including cell phones and LAN lines. Some of these expenses may be broken out and expensed separately by department. For example, telephone expenses directly associated with programming (request lines) or engineering (T1 lines, transmission lines, etc.) may be reported in those specific departments.
• Third-party-provider expenses such as payroll service fees.
• Other miscellaneous expenses.
Key Expense Controls and Measures
The first step in controlling expenses is breaking out budgets by line items. This allows the reviewer to flag areas that seem out of whack or inconsistent. Ongoing variance analyses during the year will also help flag areas in which expenses exceed budget.
For companies managing multiple stations, systems, or networks, leveraging the buying power of the group can reduce costs. For example, establishing a master contract with a national office-supply store that delivers the goods to the individual locations can reduce office-supply costs at the local level. In addition, employee paperwork for payroll and medical benefits can be administered electronically through new software packages. Television stations or groups may also look to group programming negotiations and the use of per-program options for music license fees (see Chapter 14) to control costs.
Centralizing operations such as sales, traffic, broadcast control rooms, and cable headends, as well as automating functions at multiple locations, may also reduce costs. Centralization minimizes both capital investment costs and operational costs. Outsourcing is often used to reduce the costs of personnel associated with the credit-and-collection functions, billing, and even in the Technical, Engineering, and IT Departments.
Local sales commissions should be evaluated on at least an annual basis. Compensation plans should be market competitive to avoid losing successful representatives to competing companies. Typically, different commission rates apply to (a) direct spot revenue, (b) agency spot revenue, and (c) nonspot revenue. Each commission plan should also be effective in achieving the goals of the particular entity, and should include measurable target goals and compensation incentives. For instance, rewarding sales in a particular revenue area can be executed only if that revenue can easily be identified within the traffic and billing system. Some companies have implemented rate-based compensation plans that focus on maximizing advertising inventory. Because turnaround time for submitting commissions to payroll is generally short, it is important that commission plans are easily understandable for both the sales and accounting staffs.
In Conclusion
This chapter outlines a number of the expenses typically incurred by electronic media companies. Although expense classifications may vary from company to company, they will generally be consistent among media properties of a single company. Accurate categorization of expenses is essential because it gives management the information it needs to evaluate the performance of each of its businesses. Knowing what’s going out—and, more importantly, why it’s going out—allows the savvy business professional to stay in control of an increasingly complex media operation.
Notes
1. The authors gratefully acknowledge Richard “Dick” Petty, SVP/Controller, Time Warner Cable, for his assistance with the portions of this chapter dealing with revenue from cable operations.