If you’ve ever seen Dragon’s Den, you’ll know that a pitfall of many an entrepreneur is not knowing their numbers! As an agency owner, it’s vital that you understand a few key numbers and a few key ratios that underpin the performance of your agency
Ultimately, if you don’t know the score, you have no idea if you’re winning. This blog will (hopefully!) help you to understand some of these key metrics:
Revenue (or Gross Revenue)
Also known as sales or turnover, this is the amount you’ve earned in income during a period. This doesn’t necessarily match what’s been invoiced – as you’ll need to adjust for some timing differences. Your revenue figure should represent the value of work done during a period that you’re going to paid for (if you’ve not been paid already). This is key as most agencies work on fixed price projects, so you can only declare revenue up to the agreed fixed fee. Anything over this needs to be written off if you can’t claw it back some other way.
Your revenue figure also includes recharged costs to clients, such as media spend (Facebook, Twitter, Google costs etc). We’d recommend separating this out from ‘fees’ in your accounting system, so the revenue section of your Profit & Loss Report should look something like this:
You might also want to split out your fee revenue into Retainers and Project, to further see how your fees are currently made up.
Gross Profit (or Net Revenue)
The next key figure to understand is Gross Profit. This is your total revenue less any direct client spend. Commonly, this will be in the form of ad spend and freelance costs. By deducting these from your total revenue, you then have your Gross Profit. This figure as a % of your Total Revenue gives you a Gross Profit margin. This could look something like:
Net Profit (or EBIT – Earnings Before Interest and Tax)
Now that you have your Gross Profit figure, you next need to deduct your overhead costs during the period. These are your committed costs, such as payroll salary costs, office costs, insurance, subscriptions etc. Your final figure once deducting these costs is your Net Profit figure. Again, this figure as a % of your Total Revenue is your Net Profit Margin:
The benchmark most agencies aim for is 20% net profit margin, however this tends to get more difficult as your grow in both revenue and headcount – so for most bigger agencies it becomes less about the % and more about the profit number.
Debtor Days
A key ratio for any agency in terms of cash flow is debtor days. Put simply, this tells you how many days its taking you to get paid on average. Most of your costs get paid out on a fixed basis either monthly (salaries, overheads etc) or quarterly (VAT payments, rent) so you can’t do much to avoid them. Therefore, after being profitable in the first place, the next biggest factor to your cash flow is how quickly you’re getting paid.
There are many ways to improve your debtor days. Here’s just a few to be thinking about:
- Review your billing cycles – how are you currently billing for projects? Is there any way you can bring forward the terms or increase the % milestones to ensure that you get paid more up front or throughout the project?
- Review your payment terms – how many days do you agree to be paid in on average? Are you giving too much credit terms to your clients? Would any of them object to you asking for payment a little earlier?
- Review your current processes – are you putting enough checks in place to ensure that clients are receiving your invoices? Do their finance department require PO’s each time and if so how are you dealing with this? Are you then chasing the client enough (or too much!) for payment?
- Introduce a direct debit system – you probably pay for a lot of your costs via direct debit. Could you introduce a simple direct debit system such as GoCardless to get paid on time every time?
- Stick to your guns – if you’ve agreed payment terms with a client, don’t be too soft if they don’t stick to them. Be prepared to ‘down tools’ as a last resort and have the difficult conversations with them. Too many agencies keep working with poor/none paying clients for fear of damaging the relationship. But if you’re doing a great job you deserve paying for your work on time.
Retained Earnings (or Equity)
As an SME, your company Balance Sheet is the only accounting report that gets filed publicly. The ‘bottom’ number on here is the Equity that your company has built up over the accumulation of its existence. This is also known as Retained Earnings. This number represents what’s left over in profit after accounting for tax and drawings (usually shareholders dividends).
Theoretically, if your company was to close tomorrow, you get paid what you’re owed and you pay out everything you owe, you’d have your Retained Earnings in the bank.
The easiest way to understand equity is to relate it to a real-life comparison – a house. Firstly, you have the Asset i.e. the value of the house itself (let’s say £300k). Then you have the value remaining on the mortgage excluding interest (let’s say £250k). The balancing figure (£300k less £250k) is the £50k Equity that you have in the house.
It’s exactly the same in a business. You have Assets (cash, monies owed from clients and the value of equipment you’ve purchased), Liabilities (monies owed to suppliers and HMRC) and the balancing figure is the Equity in your business.
