By Rayanne Buchianico
When thinking about metrics in your IT business, many IT services providers go directly to the service desk. How many endpoints did we touch? How quickly are tickets resolved? Did we meet our SLA 100 percent of the time? These metrics are important for improving customer experience and internal SOPs. It’s no wonder they are at the top of the priority list.
Let’s take some of these metrics and measure them on a financial scale and ask slightly different questions. How profitable are your services? Which services are more profitable than others? Are you meeting your desired gross profit margins at individual service levels?
The requisites for accurate financial metrics are a clean accounting system and a standardized chart of accounts. Income and COGS accounts should be perfectly aligned to provide accurate and timely information. For each revenue account, you should have a corresponding COGS account.
Once your accounts and data are accurate, you can use your accounting system to quickly spot problems with your financials and profitability.
QUICK ACCOUNTING TIPS FOR PROFIT MARGINS
- Always run your reports on an accrual basis. This is really important to accurately measure income when earned. Costs associated with those earnings should appear in the same month. If you use cash basis reports, your financials will report income when you receive money from the customer. This can be in a completely different period from when you pay your vendor or provide the service. Get in the habit of matching your income and costs in the same period for accurate margins.
- Always include the percentage of income when running your P&L. Percentages will quickly highlight which items to focus on.
- Get rid of the pennies. Run your reports without the cents column cluttering the real estate.
- Collapse the report. Start with high-level accounts and calculate margins at the high level before drilling down into the detail. The high-level figures will illustrate which details you need to focus on.
HIGH-LEVEL METRICS TO WATCH
There are three important high-level financial numbers to watch for. First, look at total income to see how you are measuring up to your revenue goals for the year. Second, assess your ability to make a profit after paying all the bills with net income. As a general rule, you want that net income percentage to be at a minimum of 10 percent. Anything less than 10 percent is not a profitable business. You are working too hard to take home only 10 cents on every dollar you make. Aim for 15 to 20 percent net income margins. Some of the best in the business are bringing home 25 percent. It is possible, and you do not need to gross $5 million dollars to do it. The third high-level metric to watch is gross profit margin. This is the number that is the most flexible in your business. We can calculate this by working backwards.
- Total revenue = 100 percent of income
- Desired net income = 20 percent of total income
- Expenses are generally fixed and should average between 30 and 35 percent of income.
Subtract your net income and expenses from total income (100 – 20 – 35). This leaves approximately 40 percent of your income available for cost of goods sold. Your gross profit margin must be 60 percent to meet your net income goals. Simply stated, for every dollar you earn in revenue, you are spending 40 cents. If your margin is too low, increasing your prices will help improve it. However, simply adding new sales without adjusting your costs or prices will make no difference in your gross profit.
By now, your chart of accounts should be organized so your income streams are separated into groups with sub-accounts under each group heading. Looking at the group headings only, your accounting system will total all the accounts under it.
This data can quickly show which buckets of revenue bring you the most income. For instance, take total product costs and divide it into total product sales to calculate overall gross profit margin on the sale of hardware, software, and other products to determine if you are meeting your markup goals. If you are striving for a 25 percent markup on products, but your calculations show 12 percent, find out why. Have you invoiced everything that you purchased? Was the customer invoiced in one month, but the vendor billed in another?
Do this with each revenue stream and have your benchmarks and goals nearby. If you are not meeting a goal, drill down into the details of that group and determine which account is creating the undesired results.
Detail-level metrics you may want to review will include labor profits. Be sure to post your engineer salaries in the COGS section and not expenses. The total of all your technical salaries, wages, benefits, and taxes is your total cost of labor. Divide that number by the total of all human-service revenue — break fix, all-inclusive, block hours, and projects. Labor costs should be approximately 25 to 33 percent of labor-related income. Depending on your market, you may be in the higher range, but try to stay below 35 percent. If you find this figure inching toward 40 percent, review staffing needs with a critical eye or perhaps increase your billing rates.
For vendor-related metrics, many provide you with price points to help you set your margin and markup. You should hit these consistently unless you have over-purchased or are not invoicing costs back to the customers correctly. Auditing your contracts on a quarterly basis is a good idea to ensure you are capturing every cost on an invoice.
Every month when reviewing your financial reports, create your break-even sales point and use that to create sales goals for your team for the next month. You can also use that number to plan your profits and set income goals for yourself.
If cash flow is an issue, take a look at your receivables turnover rate to understand how quickly your customers are paying your invoices. A simple change in payment terms can improve cash flow exponentially.
A very telling metric is called “times interest earned.” This can be calculated by dividing net operating income, also known as EBITDA (earnings before interest, taxes, depreciation, and amortization) by total interest expense. This provides insight as to how much interest you are paying as compared to your income from operations. A higher ratio indicates a healthy use of credit. As the number gets lower, consider paying down some debt, if you can.
Finally, be sure to pay attention to the basic business metrics, such as the working capital ratio and the all-important acid-test ratio. You need to know at all times if you have enough cash to cover your liabilities.
IF YOU’RE NOT PLAYING WITH FINANCIAL REPORTS ON A MONTHLY BASIS, YOU’RE MISSING OUT ON ALL THE FUN!
I find the more attention you give an area of your business, the better that area becomes. If you focus on sales, your sales will increase. Focus on customer service and you have happier clients. When you focus on your financials, your business becomes healthy and stable for years to come. Many of the metrics listed here are often used by potential buyers of businesses and banks to determine credit worthiness. I think you will find the more time you spend with the various financial metrics and calculations, the more you will enjoy them.
RAYANNE BUCHIANICO is an enrolled agent and the owner of ABC Solutions, LLC in Dunedin, FL. She is also a partner in SellMyMSP.