Is your company’s profitability leaky? Ask yourself this: Can you see exactly how and where to improve it?
This series of articles is examining five common mistakes that service-based businesses or agency-type firms make in tracking their profitability — mistakes that limit their ability to see and fix those numbers. (Agencies are companies for which human labor is the revenue-generator.)
It’s important to slice and dice your profitability in a number of ways, so you can find the weaknesses. In part 1, we covered tracking profit by customer and project to find out which are more (or less) profitable and why.
Work type is another important way to look at costs and revenues, yet many agencies overlook it. Knowing profitability by employee type, group or function gives you tremendous insights. Let’s look at this, to help you find your weak spots, fix your money leaks and strengthen your business.
1. Tracking Profitability by Employee Type or Group
Work-type profitability issues vary a bit by business. In a law firm, you’d want to ask yourself: What is profitability for my associates? For my senior associates? For my junior partners? Across every kind of work.
In a software development organization, you could ask, what is this particular group’s profitability? Maybe you have a UI/UX group, a deep software development coding group and then an architecture group. How profitable are each of these functions?
What we’re trying to figure out is this: Where is your profitability weak? In creating proposals and in building budgets and estimates, you divide work between groups of employees. The client might not see all this detail. But you’re saying, “I believe that architecture should do about $50K of work, UI/UX should do about $100K and development about $100K.” Adding that up, you create a budget of $250,000 for the project.
By tracking work-type profitability, later you may discover that your architectural services team took three times as long as expected to do that job.
What does that tell you? Is your architectural team subpar? Was there an issue with the client? Did you simply bid and price that job wrong? And why?
Most importantly: How do you fix that weakness so it doesn’t happen again? When you consider doing architectural services work in the future, you want to be able to answer these questions.
Work-type profitability analysis gives you more granular metrics. It helps you drill down to root causes of profitability leaks. You’re not just looking at payroll by department, but you’re slicing and dicing it in different dimensions. This analysis deepens your pricing knowledge and improves future pricing of your projects or services.
2. Building a Deeper Chart of Accounts
Many times at AVL, we end up helping an agency modify their chart of accounts. That’s a list of all the buckets you divide your costs into. In order to track profitability well, you might have to adjust what buckets you use. Going back to the law firm example, a lot of agencies we see will have only one revenue account and one labor cost account. We come in and say, let’s add these accounts: Revenue: Partners, Revenue: Principles, Revenue: Senior Associates, Revenue: Associates. And Costs: Partners, Costs: Principles costs, etc.
Now you have more immediate visibility to margin by associates or partners. Enhancing your chart of accounts allows you to do see this analysis in a more immediate way.
You do this with other direct costs and overhead, too, and get that into your costs by work type. You can build accounts like: Payroll Taxes, Benefits, Travel Costs, and possibly overhead costs like rent. Set it up, and then track it.
When you have these accounts and analyses in place, you can start saying things like this: “Project A was lower in margin because it was heavy in associates, which have a lower margin for us than partners. Project B had more partner time, which has a higher margin for the organization, so it was more profitable.”
Tracking costs by employee type or group can help you add a lot of value onto your bottom line. It can help you decide what types of projects to take on or how to structure all your projects more profitably. To get there, you may need to set up a more detailed chart of accounts and begin to use that new dimensionality.
I’m sure you will be glad you did.
In the next article, I will walk you through billing or invoicing problems that are too common in agencies, ones that can really gum up cash flow and profitability.