We are living in a golden age of outsourced digital services. Top talent from around the world are providing their expertise to companies just when they need it. From presentations to podcasts and marketing to make-overs, the possibilities are endless. But online agencies need help too! While you may be an expert in creating slick websites or amazing content, chances are you are not a financial expert. Sure your bookkeeper says he runs a tight ship but has he ever talked to you about these 9 key metrics for your business? Understanding these nine key metrics can be the difference between surviving and thriving for your digital agency.
Here is a link to a similar version we did for e-commerce businesses.
1. Revenue (per segment or service)
Revenue is the most obvious metric. It is also a key metric but is overly relied upon to the exclusion of other key metrics. Many also do not look past the headline figure to see what is actually going on. Growing revenue indicates where your service is adding value to your clients. But to see which of your services or which of your clients groups are growing, you need to track your revenue per client niche and service. For example, your headline revenue may be flat, but could reflect two declining service lines and one fast-growing line.
2. Gross Margin (per segment or service)
Gross Margin = Gross Profit / Net Revenue
Gross Margin is your basic profit from delivering your services. It is profit before overheads, interest expenses, administration, and other company-wide expenses. Revenue tells you where you are adding value to your clients. Gross margin tells you how much value you are getting in return once basic costs are taken out.
When you can break this down to the segment and service level, it becomes a powerful tool.
If you have high revenue but low gross margins, then you need to look at your costs or the price you are charging – are you charging too low or overservicing your clients?
If you have low volume but high gross margins, can you increase your volume?
3. Operational Cash Flow
Net Cash From Operations = Cash Receipts From Operations – Cash Outflows For Operations
Cash is the pillar on which any business stands or falls. Even if you have positive revenue, you will not survive without positive cash flow. One US bank found that 83 percent of small businesses fail because of poor cash flow.
Operational cash flow is the cash you receive from your normal business operations less outgoing cash for expenses. For digital agencies or consultants, this is the cash you receive from providing services to your clients, less cash paid out to workers, software services, etc.
A few months of negative cash flow is not a problem as long as the cash flow is positive overall for the longer period.
It is also important to note the healthy profits do not always translate to healthy cash flows. For example one of our clients had growing revenue and a healthy profit margin but their invoices were being paid too slow leading to a cash flow problem.
4. Aged Receivables (AR)
Accounts receivable is revenue generated but not yet paid. Remember that revenue is generated when you provide your service, not when it is paid. Until the revenue is paid, it is recorded in Accounts Receivable.
Keeping AR low with good velocity is the key to maintaining good operational cash flow. Be vigilant and don’t let them age! The goal is to keep the majority of your receivables in the 30 days or less category. Receivables that are outstanding longer become increasingly hard to collect.
Tight AR management is often low hanging fruit to improve financial health of the agency
5. Operating Margin
Net Margin = Net Profit / Revenue
Operating margin or net margin is your gross margin less your overhead and marketing expenses. It helps you identify when overheads and marketing are eating too much into your margin.
Overall your benchmark should be 20 percent. It is ok ifor it to be lower if you are investing aggressively for growth or you are in a competitive market where it is hard to stand out. But if you are in a dominant market position and you are in cash cow territory, aim for higher than 20 percent.
6. Revenue per FTE
FTE stands for Full-Time Equivalent. It is the method for scaling up the contributions or costs of a part-time employee to a full-time basis. In this case, it is the average revenue provided by your workers on a full-time basis.
You can use this to benchmark employees in your business but to also compare your workers to industry benchmarks. Intuitively, you’d say the higher the number the better – and that is true – BUT if it is too high your team may be maxed out, limiting future growth. It could also signal you’re underpaying your team, increasing risk of key staff turnover.
7. Gross margin per FTE
This is the gross margin version of the revenue per FTE metric (#6). The higher the better and useful for benchmarking.
8. Customer Acquisition Costs (CAC)
CAC = (Total sales and marketing spend acquiring new customers) / (Total number of new customers)
Customer Acquisition Costs is the average cost for acquiring an additional client. It is driven by the marketing and sales costs needed to acquire a new client. Keep in mind, the marketing and sales cost is not only the out of pocket costs in ads, events or software, but also includes the salary cost of the team members working on it.
Of course you’re looking to minimize the CAC. But, what CAC is acceptable depends on the LTV of your customers ( #9) and your gross margin levels (#2). A higher gross margin and higher LTV means you can accept a higher acquisition cost per customer, allowing you to invest more and grow faster.
9. Customer Lifetime Value (LTV)
This is the average lifetime revenue generated by each of your clients. From their first engagement of your services to their last.
When compared against CAC it shows the additional benefit of each client over the long run. So the bigger the difference between LTV and CAC, the more profitable each client will be.
If and when CAC becomes greater than LTV*gross margin percentage, resolve this as your highest priority. Either find ways to increase revenue from each customer or reduce the acquisition costs.
The simplest way to increase revenue per customer is to of course increase prices. But in a competitive market this is not always possible.
One way to increase revenue per customer is to offer new services adjacent to your existing offering. For example, if you are providing marketing services focused on Facebook, consider expanding to other platforms like LinkedIn.
Reducing churn is also key. Through exit surveys or targeted conversations, find out the main reasons customers are leaving and then address those concerns. Another way to reduce churn is to offer last ditch deals to clients set on leaving – but use this sparingly so as your clients don’t expect it.
To reduce acquisition costs, try mixing up your marketing channels. If you are over reliant on traditional paid advertising, consider more cost effective services such as in-bound marketing and affiliate marketing.
Nine metrics may seem like a lot but it is much easier to track than trying to gauge the overall financial health of your digital agency or consulting business.
Further, these are key metrics that pinpoint key areas of your business. Paying attention to these metrics will guide your decision making and also help you achieve your business plans.
Insight Matters also provides a service where we walk clients through monthly or quarterly reviews of these metrics. Investing in a dashboard and reviews can help you grow your business further and also avoid little problems from turning into show stoppers. Sometimes seeing the metrics is not enough, you need someone to help you understand them.