When you started your business and ate everything that you killed, profit was a meaningless concept - you took home what you billed. But, as you grow you are likely to find that net profit margins reduce significantly and are stubbornly hard to get back up.

What do we mean by net profit? It’s not a dumb question. If you’re an owner-managed business then book profits may be skewed by the way the shareholders split salaries and dividends each year. However, if you entered conversations about a sale, a potential purchaser would adjust the profit as if all the founders were taking market rate salaries and then apply a multiplier to that. We suggest you do the same to work out the ‘true’ profitability of your business as someone else would see it.

So what should your ‘true’ net profit be? Obviously benchmarks depend on location and market, but on average, medium-sized practices have the potential to make around 25% net profit.

Not making that much? It’s important to ask yourself why. Not just because of  the impact reduced profits have on the returns for founders, but because of the obvious impact on cash flow and valuation. This leads to massive implications for the potential to invest in new ideas, competencies and markets, and your ability to attract and retain key talent.

In extreme circumstances, it is surprisingly easy to fall into a “profit trough.” This trough can not only sink a business, but the climb out can become very difficult if it gets too deep or too steep. You can end up just being pleased with getting back to profitability and missing untapped rewards on the table.

But don’t worry, there are lots of reasons why you might be making less money, and each of those reasons can be viewed by the optimistic as mere opportunities for improvement. Here are a few margin-depleting problems that we see a lot, but which are easy to address.

Getting recruitment wrong.

It’s easy to over-hire, or to hire people who look fantastic on paper but turn out to be far from it in practice. That’s why, on balance, we think that running with a proportion of your resource as freelancers, say 30%+, makes sense (don’t miss our white paper on the best way to do that). Consultancies assume that it may be too expensive to pay freelance day rates, but once you take into account the ongoing costs of permanent staff, plus their non-utilised time and employment rights, it’s less clear-cut.

Engaging too many support staff.

In many firms, the ratio of non-chargeable to chargeable staff is too high. It’s perfectly possible to outsource back office services or use the latest technology to reduce the need for loads of manual work - in fact, see our blog on the subject here. And do you really need a PA when even calendar management is easily done by software such as Calendly? Another route to reducing overheads is to make senior staff more accountable for things like invoicing and cash collections. As an example, one larger firm of our acquaintance only pays bonuses to its staff when project cash has been collected, which results in markedly different behaviour from their senior team.

Not pricing to a margin.

It may seem like a common sense approach, but not every firm sets a standard margin, then pricing all projects to make sure they achieve it. The advantage of pricing to hit or exceed a standard margin is that, as long as nothing unforeseen occurs on the project, you can’t fail to produce a decent gross margin. After that, it’s just a matter of managing the overheads to get a decent net profit.

Being unrealistic about sales.

Sales meetings tend to be competitive places, with Senior staff vying to claim the biggest opportunities and demand that the best team members be earmarked for them - and the wrong behaviours can actually lead to revenue shortfalls or resourcing nightmares. In our view, the right way to manage sales is to conservatively weight each opportunity, prune those that lack significant reward and closely track the allocation of team members to proposals in order to avoid resource clashes.

Not managing job profitability.

Most firms aspire to do this, but in practice the majority spend their meeting time focusing on the sales pipeline, and tend not to give due attention to the margins of running jobs. Our recommendation is that firms review the actual running profitability of each job at least once each month, possibly more frequently for shorter projects, and take action with any that are falling below the firm’s target.

Not managing utilisation.

Under-utilised people within the business are at best an opportunity cost, and at worst a sign that you have the wrong staff working for you, whilst overburners may be amongst your best staff, but may suffer burnout. Most firms tend to measure utilisation and report it after it has already had an adverse affect on profitability, but it’s much more effective to have forward-looking loading estimates to ensure your team is balanced across your order book and the projects coming through your sales pipeline.

Spreadsheet spaghetti.

Spreadsheets are free and infinitely flexible - but that comes with a price in terms of errors, admin overhead and speed of movement. Many of these issues can only be fixed with a flow of high quality, accurate information and forecasting. Often we see overuse of spreadsheets getting in the way of this.

Not billing all time and expenses.

Although a fundamental error, this happens more often than people care to admit. Poor systems and lack of discipline around timesheets and expenses can lead to delays in getting the data you need. Often you simply can’t go back to the client and ask for an extra £220 purchase order for the train tickets that a consultant forgot to claim on time - and back-office setups where job management is not automatically linked to job control are another margin leak waiting to happen.

Sorting out the situation

None of these recommendations are difficult to implement, but they do require a combination of:

• a clear focus on creating a culture of running a profitable business
• leadership that comes from the top - if your own timesheets, expenses and job financials are not up-to-date, then how can you ask other people to do what you’re not willing to?
• the right software - spreadsheets and ad hoc tools are not only inadequate as your business grows, but they increase overheads through the additional back-office effort required to make them function
• consistent execution to avoid slipping back into old habits

Is Metis one of the answers?

Nobody ever thinks their own baby is ugly. But we’re really proud of Metis. It comes with built-in expertise in the areas set out above. It won’t hire your team, write proposals or make the coffee, but it will give you insight into your key metrics, updated in realtime. It encourages behaviours that focus yourself and your team on the things that matter most: pipeline management, resource utilisation and job profitability.