How confident are you in the financial health of your company? Having a solid understanding of your finances can make a huge difference for small business owners. Not only does it help you make decisions about when it’s time to hire a new employee or whether or not to invest in new equipment, but it also enables you to sleep better at night!
While your business grows, there are a few metrics you need to understand and review on a regular basis. As a distributed accounting firm offering Virtual CFO services, we work with creative agencies, helping them focus on the following key metrics:
- Money in the Bank – We recommend for any business, no matter what size, that you maintain at least 10% of your annualized revenue in the bank at all times. For example, a $3M company should have about $300K in the bank account at any given time. This practice is extremely important for businesses as it prevents small issues from big issues and it reduces big issues completely. If you don’t have that 10% in the bank, make that a goal for your company. Keep in mind that in addition to that 10% you’re going to want to set aside your tax reserve. For simplicity sake, we recommend setting aside 40% of the net income on a regular basis.
2. Production Metrics – Production metrics will differ depending on your type of business. We typically work with service-based companies, where everything is based on time, and for this type of business, we look at utilization rate, average bill rate, effective rate, and effective cost.
- The Utilization Rate is the billable hours that you expect an employee to bill throughout the entire year. You’ll want to take into consideration holidays and any unbillable time and then take the final number and divide it by 2080 which represents a 40-hour work week. The utilization rate will change every month based on the number of days the employee works in the month, the number of business days in the month, holidays, etc. Once you determine the utilization rate per person, extrapolate that for the team.
- Next, we look at the Average Bill Rate, taking your revenue and dividing it by the billable hours. If you know you’re going to bring in $3M in revenue and you know your average employee is expected to bill 1,500 hours per year (for example) and you have 10 employees, then your average bill rate would be $200 ($3M / 1,500 x 10). Or, if you’re looking at a specific project and the invoice is $10K and you know the project will take 50 hours, then you can take $10,000 divided by 50 to get your average bill rate which would be $200.
- Once you have the utilization rate and the average bill rate, you can multiply the two to get your Effective Rate. Let’s say the effective rate is $100 and we want to maintain a gross profit margin of $50. In that case, you’d want the effective cost to be the difference between the two. The effective cost is the fourth and final production metric.
- To calculate the Effective Cost, you take the producer’s salary and add their benefits, or their burden cost, which is typically about 25%. You divide the total by the 2080 hours and that gives you the effective cost per hour for each employee. If that comes to $50, you have a 50% margin there, assuming the effective rate is $100, which is great.
- Financial Metrics – Company expenses fall into four different buckets:
- Admin Expenses: admin payroll, benefits, education, office supplies, travel, etc.
- Production Expenses: production payroll, benefits, education, software, etc.
- Marketing Expenses: marketing payroll, software, marketing supplies, etc.
- Facility Expenses: rent, maintenance, utilities, property taxes, etc.
For businesses doing between half a million to a million dollars in revenue, we see owners typically take about 20% of that as salary, distributions or a combination. This is part of the admin expense for the company. As a company grows, that percentage changes. With a $1-5M company, we see owners typically take about 10%. Over $5M, the percentage might be about 5%.
From a net income perspective, you want to strive for 15% or greater. A well-run service-based company is going to be closer to 25%. In order to grow and build cash, you need to have a solid net income.
- Pipeline Metrics – Let’s say you have a solid business. You’ve got cash in the bank, production is looking great, you’ve got your team in line and your net income is looking fantastic. Sounds perfect, right? But if you don’t have enough in the pipeline, that’s a huge red flag for what’s to come.
To determine your pipeline metrics, you want to look at your contract overcapacity. The contract is what you currently have locked in—your recurring revenue and any additional unbilled invoices you have out there. Divide that by what your team can actually produce. If you know you can produce $300K and you only have $240K under contract, your contract overcapacity is about 85%. This number on its own doesn’t mean a ton. You’ll want to compare this to your trend over the last 3 months.
If you typically pick up 15% and:
- You are at 85% capacity over the next 3 months, then you are in good shape!
- You are at 65%, then you will probably not hit your revenue goals.
You are at 95%, then you are in great shape, BUT you may need to hire employees (if it’s a long-term trend) or contractors (if it’s a short-term trend)
These are metrics we focus on with our clients as they are the most important metrics for business owners to understand. The exact metrics will vary a little based on the industry, but every business has a version of these metrics that the owner can focus on. These metrics should be prepared and reviewed every single month, and they can be used as a guide for every decision an owner needs to make for the company.
About the author
Jody Grunden is the Co-Founder and CEO of Summit CPA Group, the leading provider of Virtual CFO
Services for creative agencies as well as one of the largest Virtual CFO firms in North America. Jody is a member of the AICPA, the Forbes Finance Council, and the Indiana CPA Society, including holding a seat on INCPA’s Innovation Council. Jody is passionate about changing the way people think about accounting. Author of Digital Dollars and Cents, he literally wrote the book on helping digital companies create a financial roadmap to success.
About Summit CPA Group
Summit CPA Group is a distributed virtual CFO firm with a non-traditional approach to accounting. Their amazing team of CPAs and accountants provide professional Virtual CFO Services and 401(k) Audits for companies all over the United States—many of which are remote companies as well. The Summit team fully understands the accounting, bookkeeping, cash flow management, and business tax nuances that come with being distributed, and they love helping clients overcome these challenges through their own experience and expertise.