Four Pillars of Financial Success: Metrics and Tools to Grow Profit and Build Cash
There’s a lot of talk among the media these days that things might get a little shaken up in the financial world as we start out this new decade. As we approach 2020, forecasting is going to be important for business owners. Looking back at what happened with the economy in 2008, we learned that you can weather any storm if you’re properly prepared, and preparing for financial success comes down to four core pillars.
Taken directly from our recent webinar with Adweek, here are the Four Pillars of Financial Success:
1) Money in the Bank
There’s a great business quote: “Revenue is vanity. Profits are sanity. Cash is king.
When an agency we consult with comes to us and asks if they should pursue a particular opportunity, the answer we give them is dependent upon whether or not they have enough cash in the bank. If they do, then they can pursue the opportunity, but if they don’t, then they have to let the opportunity pass by. Cash is a competitive advantage!
When you have money in the bank, you have the ability to weather the storm. You also have the ability to take advantage of opportunities that present themselves. So how much cash do you need?
We advise clients to keep 10-30% of their annual revenue in cash which equates to about 2-6 months of expenses. There a lot of factors that go into the calculation of your cash reserve goal, however the biggest one is recurring revenue. For example, if you have a high level of recurring revenue then your cash reserve goal would be closer to 10% whereas if you have little to no recurring revenue you will want to work toward a goal closer to 30% of your revenue target. Keep in mind in addition to the tax reserve you need to have a separate reserve for taxes.
In order to keep things in order we recommend three specific bank accounts:
- Operating Account – Checking account for paying the bills and making payroll. This cash is part of your 10-30% reserve goal and we recommend keeping the equivalent of two payrolls in the operating account.
- Reserve Account – The remainder of cash should be place in the reserve account. This account should be a money market account or something super liquid that allows you to gain a little bit of interest on your money.
- Tax Reserve Account – This account ensures that we’re not mixing tax dollars with the company’s dollars. We recommend transferring 40% of your monthly net income on a monthly basis. This helps provide clarity on what’s your money and what belongs somewhere else.
On the people side, we want to look at how many hours we can expect an employee to bill. It’s important to look at the expectation rate and the utilization rate:
You probably hear a lot about Key Performance Indicators (KPIs), the metrics that will help drive your business. When it comes to production, we like to focus on two specific levers: the people who are doing the work for us and the amount we can charge our clients.
2) Production Metrics
- Expectation Rate – The number of weekly billable hours divided by the total hours available per week. In other words, how much you want each person to bill on a regular basis, i.e. 36 hours out of a 40-hour work week.
- Utilization Rate – The number of weekly billable hours divided by the total hours paid. In other words, how utilized you are after what we call “culture hours” – PTO, holidays, etc.
On the billing side, we want to look at the standard bill rate, average bill rate and effective bill rate:
If we expect employees to bill 90% of their time to a project but the reality comes out to 75% when the utilization rate is factored in, that will make a big difference when it comes to forecasting.
- Standard Bill Rate – The stated amount that you charge the client, i.e. $200/hour.
- Average Bill Rate – The total revenue that you charge your client divided by the total billable hours. Are you actually getting $200/hour, or does it come out closer to $180? A 5% difference between the standard bill rate and the average bill rate would be okay, but if that difference is higher than 10%, that would indicate there’s a delivery problem or a sales scope problem that needs to be addressed.
- Effective Bill Rate – To calculate the effective bill rate, you want to divide the total revenue by the hours paid. Another way to calculate it would be to multiply your average bill rate by the utilization rate. In other words, how much are you making per hour for every hour that you employ a production person on your team?
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3) Financial Metrics
If you’re running a business, profit is not a dirty word. Your business needs profits to build cash, and it needs cash to do really great things.
Your net income should be 10-25% of your revenue. In my opinion, 10% is the “new break even.” I recommend that you build a plan that puts you in the 15-20% range for net income in order to account for any potential fall off.
4) Pipeline Metrics
When it comes to your pipeline, it can get a little tricky. You can’t completely map it out because what you’re dealing with is possibilities. I recommend finding a good resourcing tool and CRM. This is where all of that planning and preparation comes together to show you where you need to be. You can look at your pipeline and merge it with your forecast.
You want to look at your contracted work compared with your capacity. You should be able to assess with your team what you’re built for in terms of revenue. You should know what your revenue goals are month over month. Then you can take your resourcing—your contracted work—and add that in. This helps you visualize where you’re going to be months down the road so you can determine whether or not it’s time to hire new employees.
These are metrics we focus on with our clients as they are the most important metrics for business owners to understand. You have to have the financial balance in place to get your targeted net income. You have to know your production metrics and leverage those to prepare a dynamic forecast. Finally, you need to make sure you’re integrating and staying on top of your pipeline.
Again, “Revenue is vanity. Profits are sanity. Cash is king.”
About the Author
Adam Hale, CPA is the Co-Founder and COO of Summit CPA Group, the world’s largest Virtual CFO firm specializing in digital agencies. Adam and his team have worked with hundreds of agencies helping them clarify direction using Summit’s forecasting and KPI tracking methodology. Adam also has extensive experience assisting clients with M&A planning, lender financing, scaling, as well as employee performance plans.