By way of refresher, the July column focused on using financial ratios to manage profitability. The basics were discussed: using a time and billing system; prepare a budget; watch staff productivity, etc. It also reviewed industry benchmarks that, according to industry consultants, are indicative of thriving firms. One key benchmark for example is that agency operating profit should approximate 25 percent.
Building blocks to profitability
Rick Gould, Managing Partner of StevensGouldPincus, coined a phrase, “The Breakthrough Equation.” The equation sets revenue at 100 percent and targets labor at 50 percent of revenue, operating expenses at 25 percent of revenue leaving operating profit of 25 percent. From operating profit income taxes need to be paid. Therefore, the amount of profit that can be reinvested back into the agency or used for other purposes can be half of the operating profit.
To put this into perspective, if revenues are $2M, bottom line profitability will be $250,000. Not bad, but nothing to write home about either. Also, in looking at overall profitability, owner compensation needs to be “normalized.” The salary of an agency owner can be $250,000 for one agency and $500,000 in another, both having 25 percent operating profit. Therefore, I believe the industry benchmark should be at 33.3 percent for operating profit. Can this be done? I believe it can!