Financial metrics are the final measure of all the work that gets done in an agency. With everything that goes on in an agency, the financial landscape can be unclear and even confusing. So its important to get clarity on what’s important and what’s not important, in terms of the information you need to help you manage your agency’s financial performance and outcomes.
This is the 6th in the series on key performance metrics for your agency. You can view the other 5 videos here.
If you do a google search for terms such as agency or business metrics or similar, you will get a large number of results that look something like:
- “The top 5 metrics that matter to agencies”, or
- “7 KPI’s to keep you agency profitable” etc etc.
I suggest that you be quite careful in terms of understanding what these articles are saying in and how those relate to your business in terms of what they measure, but more specifically what they don’t measure.
There are typically a lot of moving parts in an agency, some of which have can have a profound impact on results without you necessarily connecting effect to cause, on both a short and long term basis. If you rely only on 5 or 7 metrics, there could very well be areas in your business that are not receiving the level of scrutiny they really need. The correct number of metrics may vary from agency to agency and in terms of the adage that is the theme of this series of videos, namely what is not measured cannot be managed, with only 5 to 7 metrics there may insufficient visibility of important aspects of your business and therefore ineffective management attention and action.
And so on to agency financial metrics. So far in this series we have cover 5 other measurement domains. Namely: Client acquisition, operations, employees, clients and business. All of the activities that occur within these domains ultimately produce an overall result which aggregates to become visible from your financials. There is an abundance of information about common financial KPI’s out there, and you would do well to familiarise yourself with them, but I’m not going to cover any of that here.
Headline financial numbers
Unlike most other business types, the correct headline financial figure to be looking at in an agency is Gross Profit. This is defined as Revenue minus cost of goods sold. The traditional headline financial metric, Gross Revenue, is not a useful metric in an agency situation as typically there are a number of cost of sales items that result in this having very little real significance from a management point of view. Unlike revenues, gross profit is not a measure of how much money you are billing, but how much of the revenue you bill is actually yours. Some people refer to what I am calling gross profit as “Adjusted Gross Income” or “Adjusted Gross Revenue”.
The next metrics are to do with cash flow. Whilst profit is clearly very important, it’s cash flow that keeps the wheels turning and the business strong. A business can appear profitable but fail due to inadequate cash flow. Managing your agency to cash flow goals is a much better approach than managing it to profitability goals. Cash flow is driven by quite a number of factors such as payables and receivables, capital expenditure, wages growth etc. But the two cash flow components that are key financial metrics in an agency are: Work In Progress and Debtors Days. These two elements can quite quickly run away from you and get you into a tight spot unless you keep an eye on them. Good control of these will maximise your ‘operating cash flow’ ensuring that your agency remains liquid. Once capital transactions are taken into account, the ‘free cash flow’ is left for the purpose of distribution via dividends.
Productivity and profit contribution
Agencies make money by selling services. Depending on the type of agency and the way it is set up, these services will be provided either directly through the work done by company employees or by systems that the agency has invested in or some combination of the two.
The important metrics associated with each of these are
- attributable wage productivity
- attributable asset productivity
Attributable wage productivity is the amount of profit attributed to wages paid, to produce the profit and Attributable Asset productivity is the amount of profit attributed to the investment in revenue producing assets. These financial metrics will tell you how much profit is being generated by human effort through wages vs how much through investment in productive assets and the balance of these will have an important impact on scalability and business valuation.
It is very useful to be able to measure the profit contribution by department or by work type. These types of financial metrics are very simple to set up using appropriate general ledger account codes available in most accounting systems. Simple and very useful.
Probably the most important financial metric of all is operating cost per hour. This is a value that you need to keep an eye on in order to derive your charge out rate. Using the billable hours you have available, you will be able to work out the cost per billable hour and from there it’s a simple matter to verify that your hourly charge out rate includes sufficient margin for you to make the profit you are after.
During this video series, I have covered approximately 30 financial metrics that I consider relevant to all types of agencies.. Do you need them all? No you don’t. A lot depends on the age and stage of your firm. But as I have pointed out repeatedly is ‘that what is not measured cannot be managed’. If you want to do a great job of managing your agency, you will eventually use most of these. As your agency grows and progresses, you will be faced with additional challenges that you will need to manage and the more you need to manage, the more metrics you will need.