The book of Ecclesiastes begins, “Vanity of vanities! All is vanity. What does man gain by all the toil at which he toils under the sun?” If your creative service practice is not operating profitably then the answer to this question is probably, “not much.” Of course you could be profitable and still not have much of an answer to that question. But without profitability your business may feel an awful lot like striving after the wind.
It’s often said that a business exists in order to make a profit. And profit is indeed necessary, but personally I disagree that profit is the ultimate purpose for business. A well run business can do much good in the world: provide needed goods and services, employ people, innovate, and create beauty. But without profitability a business will not do much good, at least not for very long.
If you’re regularly chasing after late invoices, worrying if there will be enough cash to cover payroll, and anxious about your new business pipeline, you probably have a profitability problem. You might be feeling like you’re grasping at air, trying to get a grip on stability, only to have it elude you month after month.
If that’s you, you’re not alone. Most freelance practices and creative services firms struggle with profitability. Unfortunately, profitability problems get camouflaged as cash flow problems, or new business problems. And typical design project payment terms further conceal the real issues. If you get paid 50% upfront on a new project it might make your cash flow look good for now—but this might be a false positive. Because that positive bump in cash flow will slowly dissolve as you incur the labor expenses to get the work done. Soon that bump might become a ditch, leading to a desperation to collect on the final invoice to cover yet another new cash flow problem. When projects take months to complete, and if you have multiple projects going at once, getting a true read on your profitability is elusive. In accounting terms this problem relates to recognizing “earned” vs. “unearned” revenue.
There are a few things you can do to improve how projects, and the revenue from those projects, flow more evenly. But at the end of the day, if you are profitable on every project, your cash flow should be regularly positive, and you should have a sufficient cash cushion to cover those rare occasions when it might dip.
Therefore, your bank statements will always be a poor indicator of your actual profitability. Rather you should run and review monthly balance sheets and compare the trend line of your total equity month by month. Balance sheets will give you a clear view, however seeing those trends can take months. You need to know if you are operating profitably week by week, in real time, so you can fix problems before it’s too late. You’re going to need better metrics, and more frequent measures.
My posts on time tracking (here and here) are an essential tools for measuring your profitability on a project by project, week by week basis. You should be able to get up to date reports on how each project is performing compared to their budgets. And you should know when and if a project is going over budget and what you can do to fix it.
Your firm should aim at a minimum net 15% profitability per year. That means that either your target hourly rate needs to take all your overhead into account, or each project needs to profit margin much higher than 15% in order to cover the cost of acquiring business, down time, professional development, and all other overhead categories.
Running and evaluating your financial reports, and tracking and reporting all your time are essential practices to identify where profitability problems are occurring. Once you identify these, you can start solving them, adjusting your pricing, adjusting your marketing, and evaluating your methodologies to improve profitability.
It’s true that reading balance sheets and running time reports may feel like burdensome toil. And for those of us with an art and design background, such managerial duties are even less attractive. But if you are diligent you can improve the profitability of your firm. And then the real good that your firm does—your ability to reward employees, opportunities to innovate and create beauty—they will increase. It helps to remember the goodness of the goal when working through the toil that is necessary to get there.