The first step in calculating net profits is for a distributor to deduct and retain from gross receipts what is known as a “distribution fee.” Theoretically, the distribution fee represents those operational/overhead costs incurred by the distributor that cannot be directly allocated to specific films. It is generally assumed that a substantial portion of the distribution fee simply constitutes profit to the studio – depending on the total gross receipts received by the studio from all films in a fiscal year.
From the gross receipts remaining after the distribution fee has been deducted, the distributor then deducts its distribution expenses. By far the most significant of these expenses relate to the costs of manufacturing prints of the film and those relating to advertising. Most distributors make a further deduction in the form of an “advertising overhead” charge, usually equal to 10 percent of the actual advertising costs.
Once distribution expenses have been deducted, the distributor deducts the interest on negative cost (the cost to produce the film). The interest is usually calculated at 2 percent over the current prime rate of 125 percent of prime rate. The justification given by the studios for this mark-up is that it is necessary to help recoup the cost of their compensating balances (funds that are not subject to interest but which banks require the studio to maintain in the account) and some studios borrow at above the prime rate of interest.
The studio will typically take the position that interest runs from the time a financial obligation is incurred. From the participant’s view, that interest should run from the time the money is actually spent. Sometimes a compromise is reached where the obligations are deemed spent (or incurred) at the midpoint of an accounting period.
Negative Cost and Overbudget Penalty
Negative cost is the net item that the distributor recoups. This expense usually includes not only the direct cost of production, but also an overhead charge calculated as a percentage of that cost, usually between 12.5 and 15 percent. For participants who have some control over the production of the film, distributors typically impose what is known as an overbudget add-back penalty. The purpose of this penalty is to provide an incentive to those who control the production to be fiscally responsible and to keep the film within its budget. It provides that for the purposes of calculating a participant’s net profits, negative cost will be artificially increased by an amount equal to the amount by which the film goes overbudget. (A relatively small proportion of all pictures ever achieve net profits. When one does, the distributor is usually so pleased that it will not want to jeopardize its relationship with the producer by penalizing him. As a result, the penalty provisions may not be invoked).
Copyright 2012 LexisNexis, a division of Reed Elsevier Inc.