Marketing agencies are masters at taking a client’s service or product and connecting it to the marketplace in a compelling, purposeful, and actionable way. Smart marketers know how to harness the essence of a story while finding the right customers who are ready to buy. Not only is it creative and strategic, but in today’s world of digital metrics reporting, very analytical as well. But underneath this energy, this zest and purpose for impact, a viable and sustainable business must be built. For those of you who’ve been in the industry for a long time, you know there are countless examples of agencies that rise and later fall when there’s an economic hiccup. However, those that understand the business inside out can thrive, insulated from downturns, and spend more time in their zone of excellence.
Here are the top financial Key Performance Indicators (KPI’s) that a marketing agency should monitor closely! For the most part, it comes down to cash flow management. Most agencies don’t languish because they lack talent, they languish because they run out of money. Here is how you DON’T DO THAT.
Labor Efficiency Ratio (LER)
This is the measurement of productivity of your labor over time. There are a lot of ways to calculate this but I would look at it as:
Gross Profit / Direct Labor
Direct labor is the labor cost specifically allocated to jobs, not including overhead. You can achieve this through time tracking and by classing in your financial management software. You can get a little more granular here and chart it for sub-segments of labor, such as project management, design, or social media management as examples. LER will challenge you to improve utilization through technology and considering other forms of labor (e.g. variable cost freelancers)
Billed vs. Expected
Sure, you closed that big deal, but it was supposed to be completed in 4 months and now it’s 6 months in and still only 80% complete. Billed vs. Expected is the variance between what was actually billed (often based on hours) and what you expected to bill. When labor is tied up on projects that run long, the most expensive implication is not just the timing delay of cash flow but also the opportunity cost of not being able to take on more work. This should be tracked on a monthly, per-job basis and analyzed to understand where the variation arose. Often it’s client-side delays, but it can also be due to poor time management on the agency end.
Project Level Contribution Margin
This is the calculation of:
Variable Project Costs / Project Revenue
The only way to get this is by properly capturing client level accounting (project costing) in your financial general ledger. By doing so, you can definitively know if a client job was profitable or not. I would also layer in the cost of acquiring the client when calculating project-level profitability. Sure, you’ve been at this a long time so you may have an instinct, but for those that want to build a data-driven business, this must be managed closely. In order to get this right, the variable costs, like direct labor, materials, and allocated overhead, must be identifiable and tracked. This can be done through time tracking software and classifying accounts payable to jobs where appropriate.
Financial Forecast / Pipeline Management
A business that’s well run will look at “where the puck is going”, which means understanding what future cash flow looks like. This is probably the #1 request we receive from Stride clients because it’s difficult to estimate and usually based on a lot of assumptions.
When you understand future cash flow, you can plan (expand or contract) with more confidence. In order to build a good cash flow forecast, you need a good command of your historical cash flow characteristics (timing to collections, average amounts billed, timing to pay bills, payroll dates, etc.). But you also need a strong view of the business pipeline. The sales pipeline should credible and weight-adjusted based on the probability of closing within a certain period of time. Then, take that closing expectation and model out the timing of cash flows based on the expected contract value.
Customer Acquisition Cost
Awesome, you closed two deals this month! But it cost you more in acquisition than the contract value. Yes, this happens. In most cases, management customer acquisition cost calculation looks like this in a given period:
(Sales costs + marketing costs) / # of contracts closed
Isolating and understanding the numerator is powerful because you can start to take action. You can implement a more effective CRM to improve conversions. Determine whether certain marketing channels might, in fact, be more profitable than others. From there you can build capabilities to increase the size of deals you’re going after while increasing profitability.
Cash Conversion Cycle
The cash conversion cycle is how quickly you turn your services into cash. The goal is to increase the velocity. When cash is freed up, you can invest it to grow more sales and the virtuous cycle continues. Imagine if your clients paid you up-front and you didn’t have to pay your employees for 30 days. How amazing that would be! Usually, it’s the other way around.
If you typically do client work, then bill them, then wait for payment, that could be ~90 days. However, you have to pay employees every 30 days. This means you have to fund 60 days of working capital in your business which could be very expensive. So long as you know revenue, cost of sales, accounts receivable, and accounts payable, you can calculate your cash conversion cycle.
One way agencies try to combat this is through recurring revenue-based models that are not directly tied to project completion. This opens up a whole new discussion around managing recurring revenue metrics.
There is no magic formula for building an agency, but there is a “roll up your sleeves” financial discipline that will help any agency survive beyond one big contract or that one amazing creative director. Agencies taking hold of their financial structure will have more confidence to make bets that will change the industry game. At Stride, we help agency owners build out their back office to support these KPI measurements. To learn more about how we can help you, contact us.