Being Profitable

When I recently read Geoff Dimasi’s excellent article I thought: this is great—values-based business decisions in an efficient fashion. But I had another thought, too: where, in that equation, is the money?

If I’m honest with myself, I’ve always felt that on some level it’s wrong to be profitable. That making money on top of your costs somehow equates to bilking your clients. I know, awesome trait for a business owner, right?

Because here’s the thing: a business can’t last forever skating on the edge of viability. And that’s what not being profitable means. This is a lesson I had to learn with Bearded the hard way. Several times. Shall we have a little bit of story time? “Yes, Matt Griffin,” you say, “let’s!” Well OK, then.

At Bearded, our philosophy from the beginning was to focus on doing great web work for clients we believed in. The hope was that all the sweat and care we put into those projects and relationships would show, and that profit would naturally follow quality. For four years we worked our tails off on project after project, and as we did so, we lived pretty much hand-to-mouth. On several occasions we were within weeks and a couple of thousand bucks from going out of business. I would wake up in the night in a panic, and start calculating when bills went out and checks would come in, down to the day. I loved the work and clients, but the other parts of the business were frankly pretty miserable.

Then one day, I went to the other partners at Bearded and told them I’d had it. In the immortal words of Lethal Weapon’s Sergeant Murtaugh, I was getting too old for this shit. I told them I could put in one more year, and if we weren’t profitable by the end of it I was out, and we should all go get well-paid jobs somewhere else. They agreed.

That decision lit a fire under us to pay attention to the money side of things, change our process, and effectively do whatever it took to save the best jobs we’ve ever had. By the end of the next quarter, we had three months of overhead in the bank and were on our way to the first profitable year of our business, with a 50 percent growth in revenue over the previous year and raises for everyone. All without compromising our values or changing the kinds of projects we were doing.

This did not happen on its own. It happened because we started designing the money side of our business the way we design everything else we care about. We stopped neglecting our business, and started taking care.

“So specifically,” you ask, “what did you do to turn things around? I am interested in these things!” you say. Very good, then, let’s take a look.

Now it’s time for a breakdown#section2

Besides my arguably weird natural aversion to profit, there are plenty of other motivations not to examine the books. Perhaps math and numbers are scary to you. Maybe finances just seem really boring (they’re no CSS pseudo-selectors, amiright?). Or maybe it’s that when we don’t pay attention to a thing, it’s easier to pretend that it’s not there. But in most cases, the unknown is far scarier than fact.

When it comes down to it, your businesses finances are made up of two things: money in and money out. Money in is revenue. Money out is overhead. And the difference? That’s profit (or lack thereof). Let’s take a look at the two major components of that equation.

Overhead Overheels#section3

First let’s roll up our sleeves and calculate your overhead. Overhead includes loads of stuff like:

• Staff salaries
• Health insurance
• Rent
• Utilities
• Equipment costs
• Office supplies
• Snacks, meals, and beverages
• Service fees (hosting, web services, etc.)

In other words: it’s all the money you pay out to do your work. You can assess these items over whatever period makes sense to you: daily, weekly, annually, or even by project.

For Bearded, we asked our bookkeeper to generate a monthly budget in Quicken based on an average of the last six months of actual costs that we have, broken down by type. This was super helpful in seeing where our money goes. Not surprisingly, most of it was paying staff and covering their benefits.

Once we had that number it was easy to derive whatever variations were useful to us. The most commonly used number in our arsenal is weekly overhead. Knowing that variable is very helpful for us to know how much we cost every week, and how much average revenue needs to come in each week before we break even.

Everything old is revenue again#section4

So how do we bring in that money? You may be using pricing structures that are fixed-fee, hourly, weekly, monthly, or value-based. But at the end of the day you can always divide the revenue gained by the time you spent, and arrive at a period-based rate for the project (whether monthly, weekly, hourly, or project length). This number is crucial in determining profitability, because it lines up so well with the overhead number we already determined.

Remember: money in minus money out is profit. And that’s the number we need to get to a point where it safely sustains the business.

If we wanted to express this idea mathematically, it might look something like this:

(Rate × Time spent × Number of People) - (Salaries + Expenses) = Profit

Here’s an example:

Let’s say that our ten-person business costs $25,000 a week to run. That means each person, on average, needs to do work that earns $2,500 per week for us to break even. If our hourly rate is $100 per hour, that means each person needs to bill 25 hours per week just to maintain the business. If everyone works 30 billable hours per week, the business brings in $30,000—a profit of 20 percent of that week’s overhead. In other words, it takes five good weeks to get one extra week of overhead in the bank.

That’s not a super great system, is it? How many quality billable hours can a person really do in a week—30? Maybe 36? And is it likely that all ten people will be able to do that many billable hours each week? After all, there are plenty of non-billable tasks involved in running a business. Not only that, but there will be dry periods in the work cycle—gaps between projects, not to mention vacations! We won’t all be able to work full time every week of the year. Seems like this particular scenario has us pretty well breaking even, if we’re lucky.

So what can we do to get the balance a little more sustainable? Well, everyone could just work more hours. Doing 60-hour weeks every week would certainly take care of things. But how long can real human beings keep that up?

We can lower our overhead by cutting costs. But seeing as most of our costs are paying salaries, that seems like an unlikely place to make a big impact. To truly be more profitable, the business needs to bring in more revenue per hour of effort expended by staff. That means higher rates. Let’s look at a new example:

Our ten-person business still costs $25,000 a week. Our break-even is still at $2,500 per week per person. Now let’s set our hourly rate at $150 per hour. This means that each person has to work just under 17 billable hours per week for the business to break even. If everyone bills 30 hours in a week, the business will now bring in $45,000—or $20,000 in profit. That’s 80 percent of a week’s overhead.

That scenario seems a whole lot more sustainable—a good week now pays for itself, and brings in 80 percent of the next week’s overhead. With that kind of ratio we could, like a hungry bear before hibernation, start saving up to protect ourselves from less prosperous times in the future.

Nature metaphors aside, once we know how these parts work, we can figure out any one component by setting the others and running the numbers. In other words, we don’t just have to see how a specific hourly rate changes profit. We can go the other way, too.

Working for a living or living to work#section5

One way to determine your system is to start with desired salaries and reasonable work hours for your culture, and work backwards to your hourly rate. Then you can start thinking about pricing systems (yes, even fixed price or value-based systems) that let you achieve that effective rate.

Maybe time is the most important factor for you. How much can everyone work? How much does everyone want to work? How much must you then charge for that time to end up with salaries you can be content with?

This is, in part, a lifestyle question. At Bearded, we sat down not too long ago and did an exercise adapted from an IA exercise we learned from Kevin M. Hoffman. We all contributed potential qualities that were important to our business—things like “high quality of life,” “high quality of work,” “profitable,” “flexible,” “clients who do good in the world,” “efficient,” and “collaborative.” As a group we ordered those qualities by importance, and decided we’d let those priorities guide us for the next year, at which point we’d reassess.

That exercise really helped us make decisions about things like what rate we needed to charge, how many hours a week we wanted to work, as well as more squishy topics like what kinds of clients we wanted to work for and what kind of work we wanted to do. Though finances can seem like purely quantitative math, that sort of qualitative exercise ended up significantly informing how we plugged numbers into the profit equation.

Pricing: Where the rubber meets the road#section6

Figuring out the basics of overhead, revenue, and profit, is instrumental in giving you an understanding of the mechanics of your business. It lets you plan knowledgeably for your future. It allows you to make plans and set goals for the growth and maintenance of your business.

But once you know what you want to charge there’s another question—how do you charge it?

There are plenty of different pricing methods out there (time unit-based, deliverable-based, time period-based, value-based, and combinations of these). They all have their own potential pros and cons for profitability. They also create different motivations for clients and vendors, which in turn greatly affect your working process, day-to-day interactions, and project outcomes.

But that, my friends, is a topic for our next column. Stay tuned for part two of my little series on the money side of running a web business: pricing!