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.
First let’s roll up our sleeves and calculate your overhead. Overhead includes loads of stuff like:
- Staff salaries
- Health insurance
- 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!
22 Reader Comments
Excellent article! I’m hoping that one of your future articles talks in detail about the tools that Bearded uses to track time, projects, invoices, etc. I find that information hard to find for the industry. (We love to talk about Photoshop vs Sketch though!)
Great read! I also struggle with making money on this work. Feels wrong to charge more than just what I need to survive. I’m having so much fun, after all! But I’m getting over it quick enough (coding = fun | being broke = no fun) and reading your experience has been exceptionally useful. Thank you 🙂
This is so good and so true. Wish I had read this before the first year of our little studio, it would have saved me a lot of mutual heartache.
I recently asked a guy who founded and runs a $10m+ year agency if he ever stops being scared shitless about the business and got a deadpanned, “No.”
I think the biggest mistake business owners make (myself included) is not planning for the future. Your article eloquently argues for a forward-thinking strategy regarding profit.
I do have one question: Is there a good one-size-fits-all profit-to-expense ratio? Or at least a good starting place?
PM services we’re currently using:
Gaétane & Michael,
Thanks! And Michael, my experience is not the same as your friend’s.
I do think it’s possible to get way more stable and comfortable, but I don’t think that happens as long as your company size is growing. If you’re running a $10M / year (revenue, I’m guessing?) agency, imagine the overhead! I have no experience with that scale, but I’m guessing that kind of contract volume doesn’t just walk in the door. 🙂
There is no magic number, I think. Ideally you want the ratio as high as possible to protect you from dry spells. But that only works to the point that customers perceive a reasonable value for what they’re paying you.
I think the ability to improve that ratio (effectively charging more for your time) comes with effort and reputation. When you’re new and unproven, all you have is being cheap! But the more you do great work, and become more and more in demand, the more you can be selective in the work you choose, and charge a premium for your experience.
Another way to play with the ratio of overhead to revenue is that you can choose a lower salary, and improve the ratio that way. That means you personally get paid less per month (lower overhead), but also work less per month before you start making profit. Which may be suitable to certain ideals – for instance, if you want to live more simply and take more time off from work.
It’s all about what you prioritize, right?
Can’t wait for your next article on Pricing! 🙂
Ryan, Jason Blumer is a CPA specializing in creative’s businesses. Like Matt, he basically also advises getting a ratio as high as possible, and he talks more about what possible might look like in Pricing Strategy for Creatives and Growing Your Design Business.
A really interesting read Matt, thanks for publishing it. I’m really looking forward to the pricing part!
We are a small agency and we find pricing is the hardest thing to do. Projected hours vs actual hours is a killer for us. I’m sure it’s the same in many trades, but if you are quoting for a complete project, rather than hourly, you are bound by that quote. Even after doing this for over 10 years it’s still a struggle to estimate correctly.
I would love to hear how other agencies handle this?
@Ryan: Matt’s right that there’s no magic number, but an average that I’ve seen some CPAs and business coaches suggest is shooting for around 15% bottom line profitability (the number after you pay all your bills/employees/contractors/etc). While it’s certainly not a signal of a successful or unsuccessful business, it’s at least an indication that you’re in line with everyone else.
Wow, thanks Matt, Rose and Dan for all the great feedback. I think I’m going to go take notes on some Businessology episodes as well.
Right now I have the luxury of a day job, but I eventually want to start building up to going out on my own. This is all extremely useful knowledge.
So Soooo True! More articles need to have this kind of no BS approach that says how it really is. If you really care for your clients you need to bill at a healthy rate, otherwise your business will not be around long enough to help anyone.
Great, great article Matt.
Not many people want to talk about the business side of design. But without making a profitable income, we as designers are not free to pursue exciting projects that actually help people, and actually have time to create excellent products.
As I have been learning more about the costs to run my own web design business I have had to raise my rates significantly in order to stay afloat. The interesting part is that I am actually getting better projects now, and people are still paying the rates!
Please post here when your next article is published!
On one hand you could say you simply followed the classic strategy of starting off working to a low price and once you’d established your reputation you raised your prices.
But what made your article so interesting for me was your writing from your own experiences which didn’t sound so clear cut and strategically laid out. And I think this better reflects how a lot of us actually experience our everyday work – I know I could relate to a lot of what you wrote very well.
I’m looking forward to the rest of this series!
A good example of what happens if you don’t cover your costs with revenue is the Everpix story which was documented online. You can search for the Everpix story they posted after shutting down or read a summary we did for our students here:
Great article Matt, you’ve really got me thinking about profitability. I’m really looking forward to your next article on pricing!
This is such a helpful article Matt. Great insight and has certainly got me thinking. Left job this year as a Senior Creative to go freelance and so far enjoying it, but making little profit. Have been thinking about a formula and this couldn’t have come at a better time. Great stuff!
Thanks Matt for this great article. Everybody understands that profit = revenue/money-in – cost/money-out. But you won’t believe how many people only focus on the revenue/money-in part and ignore the importance of cost/money-out. The equation is pretty simple. To maximize your profit, what you need to do is to increase your revenue, decrease the cost, or do both.
In terms of increasing revenue, we can either bring in more business (same as working more hours in your example), or price higher. I think a number of business owners are trying to avoid the second method due to the potential loss of customers. Therefore, I’m looking forward to reading your next article about pricing.
Like Ryan said in his comment that the biggest mistake business owners make is not planning for the future, and I totally agree with him. I think often time business owners do not have clear budget and plans to allocate the budget before they start a business. This sounds pretty stupid, isn’t it? Unfortunately, this is true when you look at the financially struggling start-ups. Based on my experience, a lot of start-ups fail because the owners don’t have clear budget before they start. I would suggest business owners to plan very carefully for the future of their businesses. The budget or future forecast sometimes (maybe most of the time) is very difficult to determine and can be inaccurate, but at least you have the idea of how much do you have and how are you going to spend it.
Anyway, I’m eager to read your next article and looking forward to learning more from it.
just wondering if part 2 is still on its way. great read, thanks!
Seriously, we need Part 2 (and 3 and 4 and 5…) sooner than later, as Part 1 is just great!
Great article. I can relate to so many of the points you raised. I used to knowingly under charge clients for the work I did because for some reason I considered making a profit to be almost dirty. Once you get over this mindset and value yourself and the quality of work you are providing for your clients everything really starts to turn around.
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