When you start an agency, your goal is to earn money with it, right?
While agency founders get into the business aiming to earn a profit, an unexpected issue can come up: figuring out how to measure that profit in the first place. After focusing so much on getting that money, you might realize you don’t know how to understand your earning potential.
After all, profit goes beyond pure numbers. It’s not just about getting them in the green, it’s about staying in the green and continuing to grow. It takes a mix of quantitative and qualitative measures to capture your true profitability.
That’s why we consulted 38 agency professionals about their methods for measuring profit. We’ll share four ratios for analyzing profitability in your finances and six ways to measure it.
You can get a general idea of your agency’s profitability by analyzing your revenue with margin and profitability ratios — metrics that show your company’s ability to generate earnings. Quickbooks shares four of them to try:
Gross profit margin ratio: Measures your gross profits as a percentage of your net sales. You can calculate it by subtracting your cost of goods sold (COGS) from your net sales, then dividing the result by your net sales.
Net profit margin ratio: Shows the net profit you create from your total revenue. Its formula involves subtracting your COGS, expenses, interest, depreciation and taxes from your total revenue, then multiplying the result by 100.
Operating profit margin ratio: Evaluates the profit you generate from your core operations. Calculate it by subtracting your COGS and selling, general and administrative expenses (besides tax and interest) from your revenue.
Break-even analysis: Identifies the point in your earnings where your business expenses balance out your revenues — any point past the break-even point means profit. You can find your break-even point by adding your fixed expenses and your variable expenses.
Two of the experts who contributed to our survey use these calculations in their businesses.
At OptimizeMyFirm, a marketing agency older than ten years with six to 10 employees, Raleigh Leonard uses a net profit margin ratio. “I take gross revenue and subtract expenses to get net profit. If you divide gross revenue by net profit, you get your profit margin. So if your gross revenue is $1,000,000 and your net profit is $400,000, you have a 40% profit margin,” Leonard explains.
Leonard adds, “Profit margins are a simple way to determine profitability. There is one thing which took me about 20 years to figure out. Most business owners focus on new business and as for profit, they just see “what’s left” after the dust settles. You can always make your profit a top priority.” If you’d like to read more about prioritizing profit, Leonard recommends “Profit First” by Mike Michalowicz.
Sasha Matviienko of growth360, a 6-to-ten-person marketing agency founded two to five years ago, uses EBITDA — another name for operating profit margin ratio. “We like to look at EBITDA levels. In other words, how much money is left if the agency after paying all the fees, salaries, etc., but before paying taxes. This gives you an opportunity to compare the efficiency of running an agency as opposed to other businesses somewhere else around the world,” Matviienko says.
In other words, with so many people and fees involved in running an agency, this analysis helps you understand your profit margins without worrying about taxes yet.
While Leonard and Matviienko highlighted net profit and operating profit margin ratios, most of the respondents to our survey prefer using a gross profit margin ratio. A total of 58.8% chose it over the other types of margin and profitability ratios.
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6 Ways to Tell If Your Agency is Really Profitable
Most of the advice we received from agency professionals came from marketing agency experts. We found that 73.68% of respondents came from marketing agencies, 7.89% came from web development agencies and 18.42% belong to neither type.
You’ll see a similar trend in the survey participants who named specific ways to measure agency profit. However, a lot of their advice relates to a general agency model over marketing-specific issues, so you’ll still have something to learn if you work outside of marketing.
Here are the 6 ways respondents measure their agencies’ profitability:
For Jordan Brannon of Coalition Technologies, a marketing agency older than 10 years with more than 100 employees, profitability relates to what he calls “organic sustainability.”
“We believe in organic sustainability, i.e., generating enough revenue that we can pay our people and our bills AND invest the profit back into our people through profit-sharing. We rarely have had to rely on loans, investors, or mergers to expand our business, and are firm believers in keeping overhead to a minimum,” Brannon says.
He continues, “My brother (who established this business) and I are genuinely concerned about growing this company and letting our work speak for itself, i.e., our clients stay with us because we generate results for them and refer us to other leads. By focusing on our clients and our people, we ensure profitability.”
So, Brannon believes that you can consider an agency profitable when it doesn’t have to depend on outside income sources. This doesn’t mean that you’re doomed to fail if you use loans or investments, of course. But, you could be on the right track if you can sustain a profit without needing them.
2. Client retention
At altLINE, a finance agency older than 10 years with 51 to 100 employees, Jim Pendergast considers specific customer retention rates a sign of profitability: “An agency is profitable if they are retaining 70% of customers. Most companies get the majority of their profits from return customers. You’ll also see that 80% of your profits come from only 20% of your customers. So, the better you are at retaining customers, you can consider your business a success.”
Pendergast knows this through experience working with many startups. “We finance many startup companies, and our records have shown that businesses that have a better grasp of customer retention are more likely to last more than five years,” Pendergast says.
Looking at previous surveys, we’d agree. During another survey we ran on maximizing agency profit, one of the contributors recommended focusing on client retention.
But, it can become difficult to track which clients are staying and going as you scale. Experts suggest tracking metrics like these to keep an eye on customer retention:
Customer churn rate: The rate that customers stop doing business with you
Repeat customer ratio: The ratio of returning customers to one-time customers
3. Project tracking
If you want to improve your profitability, you’ll need to know what parts of your business are earning and losing money. Try tracking your projects to see where you’re getting the most profit.
“The danger of looking at the overall profitability across all projects is that you don’t know which projects are losing you money,” points out Daniel Cheung of Prosperity Media, a marketing agency founded six to 10 years ago with 11 to 25 employees.
The Prosperity Media team uses Harvest to monitor project time and expenses. “The great thing about Harvest is that it allows us to input our cost (per staff member) as well as additional expenses (e.g., publishing fee for a link) which will then be compared at the end of each calendar month with the revenue from the project itself. An additional benefit of using Harvest is that we can assign certain internal tasks as non-billable (e.g. internal discussions) which we can also report to the client for full transparency,” Cheung says.
If you end up trying Harvest, make sure to add it to your Databox stack using our employee time tracking dashboards. You’ll be able to visualize what projects take you the most time and money and decide if they’re generating profit.
SH1FT, a marketing agency founded two to five years ago with six to 10 team members, also uses project tracking to measure profitability. CEO Dorian Reeves says, “Having a time tracker has been a real game-changer for SH1FT. Knowing exactly how much time an employee spends on a specific task allows you to nail down your pricing to a tee and really understand your profitability.”
Reeves advises, “Make sure you have clear processes for each service you provide, and this will create an easy-to-use time tracking system for your employees. Also, a little tip, let your employees know that this is not a surveillance system and it’s to help the agency grow by understanding what’s more profitable.”
When a profitable company spends money, they get money back from that investment — a return on investment (ROI). A higher ongoing ROI indicates that your organization invests in the right expenses.
Natasha Rei of Explainerd, a marketing agency founded two to five years ago with six to 10 employees, provides a technical definition of ROI. “To calculate [ROI], you take profit before taxes and divide it by total investment. Calculating ROI for agencies involves dividing pre-tax profits by everything that was invested into developing them. This includes salaries for all employees, any equipment purchases or rent payments made to occupy office space for your company, domain name registrations, hosting fees paid to your internet service provider or whoever hosts your website content, etc. You can then compare these expenses against any income from customer projects you accepted in exchange for the service,” Rei explains.
You can learn even more ways to calculate ROI from our blog post on the subject. You’ll see that not every ROI calculation has to involve your agency’s overall profits.
Louisa Du Toit works at Spitfire Inbound, a marketing agency founded two to five years ago with 26 to 50 employees, where ROI means more than numbers. “In my humble opinion, profitability = delivery success + future value. It is not just a once-off calculation we run per job. Profitability is about more than just the numbers on a spreadsheet, hours on a job, or cost of a single job. It is also about customer satisfaction and our team satisfaction.”
Du Toit continues, “If a job has gone a few hours over the initial estimate, but the client is delighted and then opts into a retainer, the overall profitability for the customer account is great. Add in a team that loves what they do, and your profitability also increases. The single job that may not have been profitable has returned more than its value in ROI and is thus actually profitable.”
Long story short, your initial ROI might not look like your final ROI because you can’t quantify everything that contributes to an investment’s future value. You can see this phenomenon when you try to calculate your customer service ROI since customer satisfaction can be tricky to measure.
Trenton Erker from Seattle PPC Agency, a marketing agency founded two to five years ago with fewer than five employees, offers a strong opinion about profitability in two sentences: “If you can’t step away from your agency because you’re too busy working on it, then your agency isn’t profitable, YOU are profitable. True profitability is indicated by whether or not your business is desirable to acquire.”
In other words, a business has to function on its own to earn profit and become acquirable. It takes multiple people and processes to build a true agency — especially one that gains a profit. If you find yourself not being able to let go as a founder, think of ways to create more self-sustaining processes for your team.
6. Cash flow
Here’s one last calculation for you to try as you measure your agency’s profitability: cash flow. This metric measures the money going in and out of your business in a given period. It’s one of the financial reports previously recommended by business experts consulted by Databox.
“I would say that you should assess major factors surrounding cash flow when it comes to determining an agency’s profitability,” says Connor Hewson from Assured Marketing, a marketing agency founded less than a year ago with fewer than five employees. “With any agency, the goal is to always continue to scale, and therefore it’s vital that you look past simply the income and expenses each month, quarter, or year.”
Hewson advises, “Factor what your ideal budgets are for your own growth – i.e. can you commit to a large ad spend budget for the agency itself to gain new business? Or can you target yourself in terms of growth to where you would be comfortable taking on a new cohort of employees? Running a marketing agency is certainly a business model with fewer overheads than the majority of sectors, but by creating these hypothetical overheads in relation to growth you can begin to paint a clear picture as to whether or not your agency is profitable and able to scale at the same time.”
If you need an easy way to monitor your agency’s cash flow, check out Databox’s cash flow dashboards. They work with Quickbooks, Paypal, Stripe, and other popular software.
About the author
Melissa King Melissa King is a freelance writer who helps B2B SaaS companies spread the word about their products through engaging content. Outside of the content marketing world, she writes about video games. Check out her work at melissakingfreelance.com.
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