Research shows that most businesses take 2-3 years to become profitable. So, if you started a new agency, chances are that you don’t have great profits. You need a strategic plan to keep a close tab on your finances to start earning profits.
But if your agency is older than 2-3 years and you still aren’t making any profit, you seriously need to reassess your expenditure and cash inflow. In this article, I am going to tell you how to know if your agency is running profitably. But before we get into that what does it actually mean to run an agency profitably.
What does it mean to run an agency profitably?
So, how to calculate profitability of your agency?
It’s quite simple actually. Running an agency profitably means that your collective income exceeds your expenses.
This means that if you are earning enough from your clients that you save even after paying off your team, handling overhead expenses, infrastructure, and other costs, you are running a profitable agency.
This is the ultimate goal of every agency, right?
The tricky thing with running a profitable agency is that you cannot take it for granted. If your books showed profits in the previous years, it doesn’t necessarily mean that your agency will make a similar amount of profit this year as well.
Clients come & go but you cannot control your expenses as easily. If 2 of your 5 clients left, you can’t just fire 40% of your team, right?
Gross Margin on Projects & Clients
In this segment of how to know if your agency is profitable, let’s look at Gross Profit Margins of your projects/clients.
Calculating costs and gross margin on projects & clients is a crucial part of determining the profitability of your agency. They basically are an indicator of how efficient your processes are for delivering projects to your clients without exceeding your budget.
To maintain a healthy cash flow in your agency, you have to consistently achieve healthy gross margins on your projects. Here’s how you can calculate profitability of your agency by setting your Gross Margin.
Gross Margin = Revenue – Cost of Goods Sold (COGS), where COGS is a combination of overhead expenses and direct labor costs. The revenue here can be your annual worth or worth of a project/client.
You can increase the Gross Margin by acquiring high worth projects and optimizing the cost of operations in your agency. Experts say that Gross Margin margins are a good indicator of business growth over a period of time.
Plan the Financial Metrics
Planning the financial metrics is important when you are calculating profitability of your business. Every agency has unique requirements. The way you run your agency is different from how anyone else is doing it. This is why you should choose a pricing structure that suits your services and the specific needs of your business.
“The #1 thing agency owners can do is to charge what they are worth.” – Jason Swenk, Agency Consultant.
Drew McLellan, the founder of Agency Management Institute, found a way to plan the financial metrics of your agency, especially if you have less than 200 employees. Let’s say that your Adjusted Gross Income (Gross Income – Cost of Goods Sold) is at $100,000. Given that number, here’s what your expense should look like.
- Team Compensation (salaries, health benefits, etc.) = $50k-$55k (50-55% of AGI)
- Overhead Costs (Operating Expenses) = $20k-25k (20-25% of AGI)
- EBITA (Earnings Before Interest, Tax, and Amortization Expenses) = $25k (25% of AGI)
Using these metrics to decide the pricing model of your agency will help you make a profit while providing the top quality services to your clients.
Net Profits vs Running A Profitable Agency
Knowing the difference between net profits and running a profitable agency is crucial!
In fact, this is something that is quite common in new agencies. Even if there is some kind of net traffic, it doesn’t necessarily mean that you are running your agency profitably.
In the budding days of an agency, job roles in your team are not clearly defined. For instance, you, as a founder, could be handling sales, marketing, strategy, finances, or even more of your agency!
Running your agency as such could result in earning a net profit in the first few quarters or even a year but that doesn’t mean that you are running a profitable agency. Once you start getting more clients, you will have to hire separate teams to handle different aspects of your business
“The biggest tip I share with other agency owners about this is delegating what you’re not good at!” – James Costa, Founder & CEO, Phuse
KPIs to Measure Your Agency’s Profitability
Now that you know if your agency is running profitably, here are a few KPIs you should monitor to measure it.
“If I had one specific tip for agency owners / senior teams it would be: measure everything.” – Mark Kelly, Agency Growth Consultant
What percentage of leads you receive are meaningful?
You cannot turn every lead into a client and this is why you need to identify the sources that give out qualified leads. Instead of investing in multiple sources, you can just concentrate on the most profitable ones for your agency, i.e, sources of qualified leads!
In a way, this is related to pre-qualified leads. The close rate is basically the percentage of proposals that get accepted. Let’s say that you have sent 10 proposals, with a total worth of $100,000, but only two of them get accepted. This means that your close rate is 20%.
Once you optimize your pipeline as such that you send proposals to only qualified leads, your close rate will naturally increase and so will your agency’s profitability.
CAC and CLV
Maintaining a balance between your customer acquisition cost and customer lifetime cost is important! Even if you are a new agency, try to maintain the CLV to CAC ration to be 3 or more.
The more you earn per client, the more the net profitability of your agency increases.
“When I see agencies with low or negative profit margins, it’s almost surely a sign that Billable Ratio is closer to 30-40% than 60%.” – Karl Sakas, Sakas & Company
Billable Ratio is basically the percentage of your entire team dedicated to client work. Besides the pricing structure of your services, the average utilization rate of your team plays a huge role in defining the profit margins of your agency.
For instance, experts say core team members such as developers & designers should have an 80-90% utilization rate. This basically means that they should spend 80-90% of their time working on client-billed projects/hours.
Knowing if your agency is running profitably helps you set realistic goals for your agency. No matter what services you offer, your team will play an integral role in profitably running your agency. This is where we can help you!
Resourcifi is a white label provider of web & app development, digital marketing, and software testing services. Partner with us to reduce service delivery costs and manage overheads of your agency. Contact us to know more!