what’s in the pipeline?
by jody grunden
having a solid understanding of their finances can make a huge difference for business owners. not only does it help business owners make decisions about when it’s time to hire a new employee or whether or not to invest in new equipment, but it also enables them to sleep better at night!
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as a business grows, there are a few metrics business owners need to understand and review on a regular basis. when we work with growing businesses through our virtual cfo service, we help them focus on the following key metrics:
- money in the bank: we recommend for any business, no matter what size, that you maintain at least 10 percent of your annualized revenue in the bank at all times. for example, a $3 million company should have about $300,000 in the bank account at any given time. this practice is extremely important for businesses as it prevents small issues from becoming big issues, and it reduces the impact of big issues. if you don’t have that 10 percent in the bank, make that a goal for your company. keep in mind that in addition to that 10 percent, you’re going to want to set aside your tax reserve. for simplicity’s sake, we recommend setting aside 40 percent of the net income on a regular basis.
- production metrics: production metrics will differ depending on your type of business. we typically work with service-based companies, where everything is based on time, and for this type of business, we look at the utilization rate, average bill rate, effective rate, and effective cost.
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- the utilization rate is the billable hours that you expect an employee to bill throughout the entire year. you’ll want to take into consideration holidays and any unbillable time and then take the final number and divide it by 2080, which represents a 40-hour workweek. the utilization rate will change every month based on the number of days the employee works in the month, the number of business days in the month, holidays, etc. once you determine the utilization rate per person, extrapolate that for the team.
- next, we look at the average bill rate, taking your revenue and dividing it by the billable hours. if you know you’re going to bring in $3 million in revenue, and you know your average employee is expected to bill 1,500 hours per year (for example), and you have 10 employees, then your average bill rate would be $200 ($3 million / 1,500 x 10) per hour. or, if you’re looking at a specific project and the invoice is $10,000 and you know the project will take 50 hours, then you can take $10,000 divided by 50 to get your average bill rate, which would also be $200.
- once you have the utilization rate and the average bill rate, you can multiply the two to get your effective rate. let’s say the effective rate is $100, and we want to maintain a gross profit margin of $50. in that case, you’d want the effective cost to be the difference between the two. the effective cost is the fourth and final production metric.
- to calculate the effective cost, you take the producer’s salary and add their benefits, or their burden cost, which is typically about 25 percent. you divide the total by the 2080 hours and that gives you the effective cost per hour for each employee. if that comes to $50, you have a 50 percent margin there, assuming the effective rate is $100, which is great.
- financial metrics: company expenses fall into four different buckets:
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- admin expenses: admin payroll, benefits, tech and education stipends, office supplies, travel, etc.
- production expenses: production payroll, benefits, tech and education, software, etc.
- marketing expenses: marketing payroll, benefits, software, marketing supplies, etc.
- facility expenses: rent, maintenance, utilities, property taxes, etc.
for businesses doing half a million to a million dollars in revenue, we see owners typically take about 20 percent of that as salary. we typically include owner salary as part of admin expenses for the company unless the owner is significantly stuck in production. because we don’t want to fool ourselves with the impact of the business owner’s salary, we normalize the salary of the owner based on the size of the company. there are many ways to normalize salary. this is the way we chose to do it. it is simple and based upon what we have seen in the market. as a company grows, that percentage changes. with a $1 million to $5 million company, we see owners typically take about 10 percent. over $5 million, the percentage might be closer to 5 percent.
from a net income perspective, you want to strive for 15 percent or greater. a well run, service-based company is going to be closer to 25 percent before the owner salary. in order to grow and build cash, you need to have a solid net income.
- pipeline: let’s say you have a solid business. you’ve got cash in the bank, production is looking great, you’ve got your team in line and your net income is looking fantastic. sounds perfect, right? but if you don’t have enough in the pipeline, that’s a huge red flag for what’s to come.
to determine your pipeline metrics, you want to look at your contract overcapacity. the contract is what you currently have locked in – your recurring revenue and any additional unbilled invoices you have out there. divide that by what your team can actually produce. if you know you can produce $300,000 and you only have $240,000 under contract, your contract overcapacity is about 85 percent. this number on its own doesn’t mean a ton. you’ll want to compare this to your trend over the last three months.
if you typically pick up 15 percent and:
- you are at 85 percent capacity over the next three months, then you are in good shape!
- you are at 65 percent, then you will probably not hit your revenue goals.
- you are at 95 percent, then you are in great shape, but you may need to hire employees (if it’s a long-term trend) or contractors (if it’s a short-term trend).
this is not an exact science, but it gives the owner a quick thermometer reading of what the near future will look like. to get a better feel, you should analyze your pipeline and try to determine if you have enough business in the pipeline to make up the difference.
looking at your pipeline on a regular basis minimizes any unwelcome surprises by ensuring you always have enough money in the pipeline to sustain your growth.
these are metrics we focus on with our clients, as they are the most important metrics for business owners to understand. the exact metrics will vary a little based on the industry, but every business has a version of these metrics that the owner can focus on. these metrics should be prepared and reviewed every single month, and they can be used as a guide for every decision an owner needs to make for the company.