To do a good job as a CFO, I need reliable numbers to start with and financial goals to work towards.
So, early into a new client relationship, I work with the owners to develop a monthly financial reporting package. This helps both of us better understand the business from a financial perspective. As part of that exercise, we will come up with key financial and operating metrics to analyze against goals.
As a starting point, I typically insist on including a liquidity ratio, a debt/equity ratio, profitability targets and some sort of operating unit measure. The combination of these usually tells me where we are, where we want to go and what we need to change to get there.
I recently started working with a new client in a creative service business. We set up a meeting to walk through their financial reporting to determine where we could improve it and discuss what metrics would best help measure progress.
We had already been talking about profitability and setting goals, so I expected this discussion to be fairly routine. I spent a good part of my career in the advertising industry where 60% payroll, 20% overhead and 20% profit were standard, so I thought 20% profit would be an easy target to agree upon.
But when I asked my new client how he thought about his agency’s profitability and if he agreed that 20% was a good number, he came back with a completely unexpected response.
“It was easy, back when we first got started. I thought of our clients like wheels on a car. I needed four and a spare. Now we are so much bigger that I panic whenever we lose a client. I don’t know how many spares I have. I don’t really know if I’m okay or not.”
At first, I just didn’t know how to respond. Wheels? Cars? I love using numbers to analyze businesses. Ratios and percentages are useful to me. They can be used to simplify the complexities of businesses and make it accessible, regardless of the size of the company. And every once in a while, I forget that not everyone shares this enthusiasm.
He continued, “But, I’m a word guy. As long as you can tell me everything is okay, I’ll be good.”
I wasn’t about to let him off that easy. I firmly believe that while business owners should hire professionals to handle accounting and finance, owners also need to understand what their financial reporting is telling them about their business.
I said I wanted to think about it and try to come up with something that would resonant with him.
Suddenly it hit me. Five tires with one extra was exactly the same as a 20% profit, four-fifths is the cost of doing business (80%) and the extra one fifth is the profit (20%). The concept of “four tires and a spare” made sense!
So, we looked over his client list to come up with an average retainer per client. Then, we took his total monthly billing multiplying it by 20% to come up with a target profit. Then, we took this profitability target and divided by the average retainer to come up with the number of “spare” clients needed. Finally, we took the actual profit for the month and divided by the average retainer to come up with the actual “spare” clients he had. It worked something like this:
Monthly Billing $ 650,000
Number of Clients 50
Average billing per client $ 13,000
“Spares” needed (20%) 10
Actual Profit (12%) $ 78,000
Actual “spare” clients 6
This has now become the first metric on the monthly financial reports. Of course, we also look at the other traditional financial ratios as part of the monthly review, but this gives us both a common place to start the conversation about, “How are we doing?”.
As a B2B CFO®, I work with business owners in many different industries. Each one has aspects to their business that are unique to them. And while many financial metrics can be applied across all industries, they become more meaningful and useful when modified to fit each individual company.
It may be 20% profit to me, but it’s a “spare” to my client.