Key financial metrics for agency owners (featuring Darryl Salerno)

What numbers should you be tracking -- and why?
Darryl Salerno

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Agency owners need to keep tabs on the financial health of their businesses, but many lack the backgrounds to know the numbers that matter most. Darryl Salerno’s long experience in advising agencies on financial matters makes him an excellent resource on this vital topic.

In this episode, Darryl explains which numbers agencies should be focused on and what benchmarks can help them evaluate their own success. He takes the mystery out of money matters and provides practical advice that any agency leader can put to work today.

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Transcript

The following is a computer-generated transcript. Please listen to the audio to confirm accuracy.

CHIP: Hello, and welcome to another episode of Chats with Chip. I am your host, Chip Griffin. And my guest today is Darryl Salerno of Second Quadrant Solutions. Welcome to the show, Darryl.

DARRYL: Thank you. Thanks a lot, Chip. I’m glad to be here.

CHIP: I’m very excited to have you here because you were on a and asked me anything for spin sucks not too long ago, and there was some great conversation with agency owners, agency leaders, about things that are on their mind. So obviously, that’s something that makes a lot of sense for this podcast as well. But why don’t you share a little bit about yourself in Second Quadrant before we get started?

DARRYL: Sure, absolutely. I have been in the agency management business for quite a long time I was at Burson-Marsteller for 18 years left there as Chief Administrative Officer. Although I did a lot of count work and ran the Creative Services Group for a while etc. I was also Chief Financial Officer at both Ruder Finn and later Edelman and I was CEO at what is now Havas PR.

So I’ve been in our business for a long time, but for the last more than 15 years, I consult with agencies on their process on, on managing their people on managing client budgets on managing profitability, etc. And my real goal in all of this is to see if, if our industry if agencies in our industry can actually work less hard and yet make more money. And that’s not a pie in the sky thing. That’s something I think is most definitely possible. So that’s, that’s where I, that’s where I, that’s where I live at this point. I also do stand up comedy on the side just because that’s a lot of fun.

CHIP: Well, I, the only comedy I do tends to be on these podcasts and it’s very poor. So I, you would never want to see me actually get up on stage for that. So, obviously, that that kind of background is I think very helpful and You know, financially speaking, that’s something that, that a lot of agency owners struggle with. It’s. And I think part of that is because they come into it, and they’re they’re not really sure. I mean, most most agency owners don’t have prior business experience, whatever they got was in perhaps in a leadership role in another agency, but it’s, it’s different when your own your own shop, and and you’re trying to figure out how do you how do you build something that’s sustainable, that’s profitable, and that helps you meet your personal goals. So, you know, one of the questions that I get asked a lot is, you know, how should I be measuring the success of my agency? What, what number should I be looking at? What what metrics matter? And obviously, given your experience, I think that’s an area you could probably offer a lot of insight. So what should I be paying attention to? If I’m an owner?

DARRYL: Yeah, you don’t look as there are quite a few things. I think you have to run your management books the correct way.

And what I mean by that is I see an awful lot of small to mid sized agencies that run their business. Looks on a cash basis rather than an accrual basis. And what that means basically is that they’re going to recognize revenue when the billing is done, or when the checks are received from the client. And really revenue needs to be tied to when the work is done as closely as possible. So just to be clear, retainer should be billed in equal installments every month, fine. But if you’re doing a project for three months, and you’re going to charge the client $45,000 for it, you don’t take all of it in the first month, or in two months after it’s done when you collect the check. You should take that revenue in three equal installments over those three months to try to keep the work being done, or the costs related to that, which is salaries in alignment with the revenue to take because without that information, you really can’t gauge how well you’re doing From one month to the next, are you improving? Are you getting worse? The other part of it is when you’re when when if your books are based upon total billing, and then you have what we call cost of goods sold. In other words, expenses that are taken out of that billing, those expenses need to be recognized in the same month that the bills that the building takes place as well. I seen a lot of instances where someone has, you know, hundred thousand dollars worth of gross profit one month and $17,000 of negative $17,000 the next based upon time and for all of that. Once you get that set up the proper way. There are certain metrics that you should be paying attention to, you should try to achieve a situation where your compensation costs which includes payroll benefits, payroll, taxes, etc. In A range of about 60%. Generally speaking, if you can hold that between 57 and 62%, you will wind up with a profit margin in the 15 to 20% range. Now, the compensation costs must include your Freelancer costs. And if you’re an agency owner, it must include your salary at market rates. Many agency owners think they’re doing a 15% margin. They are grossly under paying themselves. And then they take the bulk of their profits at the end of the year. But what they’re basically doing is they’re really operating at a single digit, profit margin. But they’re they’re looking at books that look like they’re 15% because they take all the profit at the end, but they haven’t paid themselves adequately.

CHIP: And I think that’s that’s one of the biggest mistakes that smaller agency owners tend to make because they’re not at that point, even if they’re reading from folks like you saying, like, you know, this is these are the percentages you should have for compensation or these are the percentages you should target for profit margins. If you’re not counting your own salary properly, that then you’re misjudging your business wildly Not to mention under paying yourself

DARRYL: without a doubt and listen, I know a lot of people say well, my accountant said I should take some of them as dividends etc. That’s fine. It’s not it’s not even a question of the it’s not even a question of how how you’re paying yourself it’s a question of what your books look like. Your management books should account for your pay at regular rate. So if you’re paying yourself let’s say 5000 a month and then taking you know, I don’t know another hundred thousand dollars at the end of the year, you should be accruing. The difference in other words, take your 5000 and accrue 112 hundred thousand each month in your in your management books. Doesn’t matter how it’s handled in your In your building or in your general ledger, what matters is that you’re looking at the numbers including that. And that’s very important for another reason to, which is, if you ever want to sell your agency, the very first thing a buyer is going to do is it’s going to set your compensation at industry standards. So if you if you go in thinking, well, I made a 20% margin, and therefore I’m going to get a whatever it is five and a half time multiple. And the agency that buys you says, Well, once we set your compensation to what we will pay you when you join us, your margins really 8% now you’re now you’re multiple might be four, or five and a half. So it becomes really critical that you run your books in the right way.

CHIP: Well, I think what you touching on here is is important too, because essentially, as a small business, you’re you’re maintaining effectively two sets of books, one that you may use for tax purposes because your accountant said this is the way to get your best tax. streaming, those set of numbers, those are fine. But that’s not how you manage the business. So I, you know, when you’re talking about how to manage it, that’s where you’re thinking about accrual accounting and, and, you know, properly representing your compensation and all those things because it, it tells you what the health of your business is and what the direction of it is. Set aside all the tax things that you may want to do

DARRYL: 100 100% Listen, at the end of the year, you can do your taxes on a cash basis with the flip of a switch, if you’re using QuickBooks or whatever, but you still to chips point is 100% accurate, which is if you really want to know how your business is doing, you have to manage the books in the right way.

CHIP: Right. And it’s very easy or pretty straightforward to go from accrual to cash, but not the other way around. So it’s always better to start with a cruel and then you can come up with cash later if you need it for tax purposes.

DARRYL: Correct. And if you’re worried about cash, your your finance person should be able to provide for you a simple cash flow report. Yes. Which that says here’s, here’s what my cash flow was the start of the month or start of the week or whatever. Here’s how much went out. Here’s how much came in. Here’s what I closed with. And that’s the starting point for the next month. And you can even project that out two months or so, based upon anticipated billing based upon anticipated collections, etc. So, don’t don’t, you can’t get caught up in the fact that your books have always been done on a cash basis. I look, I see this all literally all the time from agencies. There’s two other things I want to talk about that are related to to this subject, and that is, there are really two areas you should be monitoring on a regular basis. Okay. One of them is assuming you set your market rates your billing rates correctly, and assuming you set your billable targets by person correctly, then you need to monitor You’re over servicing on clients and your employee utilization. If those two things are relatively in line, and you’ve set your rates and your and your targets correctly, you almost can’t help but make a profit. In other words, if most if you set utilization for people between 80 and 90%, or whatever, depending upon their level, and you keep your over servicing, to 10 to 15%, you will make a profit if you set your rates correctly, and those two things counterbalance one another. In other words, a lot of times utilization, they’re hitting the utilization numbers but the over servicing is way over. The times they they agencies think that they have good control over their over servicing, but meanwhile no one is hitting their utilization targets are very few people are, if you those two things are the linchpin of organizing your information correctly. So you have to make sure that you have software that can monitor those things on a regular basis.

CHIP: So and that’s important because what you’re what you’re talking about is looking at the the building blocks that get to your, your bottom line numbers. And a lot of folks, you know, you just look and say, Okay, well, you know, I made this much profit, and she that’s great. But if you don’t look at the individual building blocks, and that’s the, you know, what you’re generating for profits on the project level, what your utilization per employee is, you know, looking at the, you know, what you’re closing for new business, on an account by account basis. That’s the only way you get realistic understanding of your business. And the only way you can do realistic projections, you can’t just look at the top line and say, Well, I can come up with 10% savings, or I’m going to see 20% growth next year. Where’s it coming from? And that’s the building blocks you’re talking about.

DARRYL: Right? I agree. I let me tell you some I literally just today heard that a recent survey that was done.

By Davis and Gilbert, that agencies that are using good time management software, have seen a five percentage point increase in their margins over the course of a year, that’s going from 10 to 15%, or 15 to 20. Those are huge numbers that just require a little bit of diligence in terms of being able to monitor that information on a on a correct basis,

CHIP: right, and a small agency that’s putting 50% more in your pocket. So 5% doesn’t sound like much, but if it’s five points on the margin, you’re going from 10 to 15. That’s 50% more in your pocket.

DARRYL: That’s exactly correct. That’s exactly correct.

CHIP: It adds up very quickly. And I think that’s something that that folks need to understand when they’re looking at their numbers. You know, one of the questions I often get asked her, you know, what are some good rules of thumb you’ve touched on Some of them from a compensation standpoint, you know, what your staff costs and Freelancer costs should be but, you know, are there other rules of thumb that you would look? I mean, I know historically, you know, folks have always looked at revenue per employee. You know, obviously, these days with, you know, so much work being freelance to, at a minimum, you’d have to look at that, I think is FT ease before you even, you know, got to a normalized way of looking at it. But do you, you know, are there other rules of thumb that people should be keeping in mind?

DARRYL: Yeah, yeah, there are a few First of all, revenue per employee, I think, is an overrated statistic, because it really depends upon what practices you have. It depends on what your businesses, you know, if you’re doing a lot of strategic work, your revenue per employee may be very high, but your cost per employee may be very high, right? If you’re doing a lot of execution work, your revenue per employee may be 50% less, but the salaries may be, you know, 80% less,

CHIP: right? location matters to I mean, if you’re in Anchorage, Alaska versus Manhattan, it’s going to be a big cost difference. So

DARRYL: exactly right. comp to income ratio makes more staffing. I agree, because that those are comparing those two together. But there are a couple of other areas, I think that we have to really focus on. One of them is that there are a lot of agencies out there that are using blended rates. And what I mean by blended rate, in other words, everybody is at the same billing rate. And while that might seem like a simple way to do things, etc, there are there are some flaws in using it when you are managing your business. I don’t care how you go to market. But when you’re managing your time, and you’re managing the utilization, and then over servicing, it has to be at market rates. And the reason for that is simple. Just saying well, we promised the client 40 hours a month, well, is it 40 hours of the owner, or is it 40 hours I’m an assistant account executive. The The reason that market rates come into effect is because what we want to say We we put in, we promised them 40 hours a month at $200 an hour that’s $8,000. Well, $8,000 is going to be a lot fewer hours of a senior person than a junior person. So you have to do it on the basis of dollars, not on the basis of ours themselves. And that gets compounded by something else, which is the, from every, every aspect that we’ve been able to ascertain. The greatest reason for over servicing in our industry is because people are working below their pay grade. We have a lot of vice presidents doing work that senior account executives or account executives could do. We have account supervisor doing work that they did as a user assistant at ease. The problem I think that we have is we put a person on an account and the client loves them because they’re really good and because they Really good to get a raise. And because they’re really good the next year to get another raise, and they get a promotion. Meanwhile, the clients still paying the same amount because it’s generally in a retainer kind of situation. Over the course of time, the person was an AE when they started on this. And after a couple of years, and now a supervisor, they’ve gotten three raises and two promotions, but we still have them doing the work that they did as a ease. And that that is a recipe for making people work a lot harder. Because you can’t, you’re going to over service those accounts significantly. Because if it takes even close to the same number of hours at a higher rate, it’s going to create situations where you’re, you’re over servicing goes through the roof, we have to get better at going back to the client and suggesting that we either need to get paid more if you want to continue to have this in place. Working on the account, or we will need to move the work down to NAE who’s been brought up to speed on this account, because the work is at work. And in my opinion, just one final thing on, in my opinion, that second option is better, because I would rather teach the he had to do that work and allow that that supervisor to expand his or her own capabilities by doing something that’s more appropriate for their grade.

CHIP: I think that makes a lot of sense. And it’s I think it’s particularly acute with small to mid sized agencies where you tend to, in general, have senior people doing more junior level work anyway. And so, and you don’t tend to have the same frequency of turnover and as many people as you can move in and out of slots as you can at larger agencies. So it it creates an additional layer of challenge that that owners need to be aware of. Absolutely. So you’ve talked a lot about market rates in this conversation. How do you figure out what the what the proper market rate is? And I’m thinking in terms of both the owners compensation and this is something that even owners who are trying to get it right often get it wrong because they’re, they don’t really have a good sense as to how to set that and same with your employees. So how do you how do you go about addressing that issue?

DARRYL: Well, there are a number of things that come out from the industry each year that they survey agencies so you can at least get what others in the industry are paying. The PR council does it records from does it you I believe there are a couple of other some of the some of the compensation companies come out with their own what it called a salary levels at each for each level price, but you can pretty much if you do a little bit of research on it.

Whether it’s PR week or a PR council or or Rick or etc You can see what is the what are the standard bill, billing rates for an agency, my size, and agency in my region and an agency within my practice area. And by looking at those three combinations, get a good sense of how you should be setting those rates and how you should be setting billable targets etc. And, and that includes looking at the salary levels for the most senior folks. It’s not going to see age, it’s not going to say agency owner, but it is going to say senior vice president or VP at larger firms, and that’s both salary and billing rates. So,

CHIP: and I think, and I think it’s important to look at that too, in context of, you know, where you are in the work you’re doing. So there’s the geographic component, but there’s also, you know, particularly these days, I think we’re seeing an increasing number of younger agency owners that we did when I first got into the game 30 years ago, you know, 30 years ago, it was, it was mostly more senior people who started their own business now. You know, it’s not uncommon for someone with just four or five years of experience to be starting their own consultancy. And so you need to look at that as well, because someone who’s got 30 years of experience, you know, probably should be assigning themselves a higher comp value than someone who’s, you know, only five years into the industry.

DARRYL: Exactly. Right.

CHIP: So, you know, are there other things that there are big warning signs to you, when you’re looking at agency finances, things that should set off major alarm bells, and the owner should be saying, Oh, my God, you know, there’s there’s something wrong here.

DARRYL: Yeah, I think I have an analysis that I, that I urge everybody to do is I’m going to fact in the software that I have it, it does it automatically because I’ve been using it for years and it’s called a building power analysis. And what a building power analysis does is it it calculates how much revenue you could generate. If everybody Your organization were to hit their utilization targets. And all the time got built. In other words, in theory, that’s pretty much the maximum revenue you could generate. Now, you’ll never get there because the some people will miss their targets usually will miss it below. Very few people will get above it. And there will be some of the servicing either intentional or not. And, but it gives you a number, and you should be able to generate somewhere between 75 and 80% of that number. So the reason that that’s important, let’s assume for the sake of argument, my building power said I could do $4 million worth of revenue. So that means somewhere between 3,000,003 million two is what my real revenue should be. Okay. So when I’m building my budget for the year, if my budget only calls for 2.5 wins I’m probably overstaffed. Okay. If my budget calls for close to 4 million, I may not have enough people. Now, that doesn’t mean that’s assuming your salaries are reasonable. And your and your billing rates are reasonable and your billable targets are reasonable. But assuming those roles generated by the industry, that’s a good litmus test to see whether or not you you have the right staffing mix. For what you need to do. And you can do it not only for the year, you could do it for just a quarter you can decide, you know, what’s my revenue for this quarter going to be etc. You got to keep your eye on that. Going forward, to make sure you have the right, adequate staff. And if you’re understaffed, maybe you can do it with freelancers for part of it. And I should talk about freelancing a little bit too. Maybe you should do with freelancers, because a less you know you can sustain that level of work for a period of time. It’s cheaper to not bring somebody on board. But and getting staffing levels. Right is is incredibly difficult for agencies. Right? It is it is the largest cost that just about every agency has. Its it is. It’s a delicate balance because you certainly don’t want to be overstaffed. But if you’re understaffed, that’s a problem too. There’s always the challenge of getting the right person at the right time at the right salary. There’s there’s so many things that go into that mix it is it is a difficult thing to get right. But it is it makes a huge difference in your profitability. It actually if I there’s almost nothing else that can affect your profitability kept getting that right. You know, yeah, this this. So little of our expenses are in other categories. Once you take care of compensation, and you take care of facility costs, like rent, the rest of it is almost inconsequential. It’s a very, very small percentage. So it really is all about your compensation to income ratios. How you deploy that information. With that being said, if you’re using freelancers, the rule of thumb we always had, rather than let the freelancer tell you how much they’re going to charge. There’s a better way to do that. And the better way to do that is to say, if this Freelancer were on staff, what billing rate would I charge them at? So let’s say I, let’s say, their billing rate, I would say, well, they’re equivalent to someone who had bill at $150 an hour. First of all, that’s the that’s the rate I would put into your time management system for them. But then that dictates how much you should pay them. Because you shouldn’t pay them more than one third to one half of what you are billing them at. So that would say if I can build this person at 150, I can pay this person at 50 to $75 an hour that puts them someone on a par with most of your actual employee. And it keeps your ratios in line with everything else that we’re talking about in terms of comp to income ratios and things like that. So, so, you know, I think that becomes a critical thing. Otherwise, you just all you’re really doing is you’re going out and winning the business. And then you’re marking up minimally on these people. They’re getting all the profit, right? From the work you did to secure the client, right? You’ll

CHIP: become an employee of your freelancers. Essentially,

DARRYL: you’re their sales rep exactly right. Maybe you could do stand up comedy.

CHIP: But well, Darryl, this is this has really been a great conversation. we’ve only scratched the surface, but unfortunately, we are creeping up on the end of the time we have available. If someone wants to learn more about second quadrant or the software that you have or anything else, where should they go?

DARRYL: Well, best thing first of all, you can certainly send me an email. It’s [email protected], you can call me 914737122 to, I’m happy to anybody that listens to this. I’m happy to engage for an hour and give you a free hour of consultation if you want. I’m also happy to give you a free demonstration of the software and a few months of free utilization if you want to try it out. I my goal, like I said at the beginning is that I’d like our industry to work fewer hours and make more money. So I would love to engage with you if that’s what your desire is.

CHIP: And as you said at the start of this recording, it’s it’s not only the desire of most agency owners the desire that you have, but it’s also very much achievable if you put the right systems and processes in place and you get the right education, to put it all together. Happens all the time. So well if you happen to be out Exercising or driving all of those links and information will be in the show notes so that you have that available to you. So you know don’t crash your car just to make a note here you can go back and collect it later. But, Darryl, I really appreciate your time today. It’s been very helpful and I know the listeners got a lot out of this. Again, my guest today has been Darryl Salerno of second quadrant solutions.