When you think about the health of your consulting firm, what is the first metric that comes to mind?
I've asked thousands of consulting firm owners this question, and I'm often told that - profit is the key metric.
But what if I told you that only focusing on how profitable your firm is or will be can lead you to financial troubles.
What comes to mind now when you're determining how financially healthy your consulting firm is?
In today's episode, I will provide you with five critical metrics for you to track to determine and improve the financial health of your consulting firm.
Understanding a financially healthy consulting firm is key to achieving longevity and profitability.
As a consulting firm owner, having a clear picture of the firm's financial health can position you to make informed business-growth decisions.
You can use many metrics to evaluate your firm's financial health, but here are the top five we use here at SYTP.
Constant Revenue Increase
Your revenue should continue to increase month-over-month, quarter-over-quarter, and especially year-over-year. The goal is for your firm to show continuous upward movement and a predictable improvement in revenue.
To keep a close watch on your revenue, you should review your income statement and track your weekly earnings against your goal.
For example, if your monthly goal is $50,000. That means each week your firm should earn at least $12,500. If you fall short one week, you need to increase the goals the following week.
Cash balance growth
Cash is your firm's superpower. Without enough cash, your firm will struggle to thrive each day. You should have at least four to six months of operating capital reserved at all times.
From a cash flow perspective, your firm should be prepared for the worst that could ever happen. For example, if COVID 2.0 occurs, how long could your firm survive. If you lose over 50% of your projects or customers, would you be able to cover payroll?
If you don't like your answers, it is time for you to begin aggressively saving to maintain 4 to 6 months of operating cash to cover monthly expenses.
Low Debt Ratio
Having an excessive amount of debt can hinder the growth of your firm. Having debt eats into your firm's profit and blocks your ability to scale.
When securing debt at that moment, you may feel relief. However, that's only a temporary bandaid to a significant cash flow problem.
The cash flow problem could be your prices, revenue decline, excessive spending, low project or client acquisition, or other factors. You need to locate the problem and solve it first, not add another problem, such as securing business loans.
It would be best if you continuously compare your debt-to-assets ratio. You want to have twice as much in assets then you do in debt.
Steady or Declining Expenses (or Outflow)
The goal of a growing consulting firm is to have more money entering than exiting always!
As your revenue increases, many consulting firm owners make the mistake of increasing their expenses. When in fact, you want to keep your expenses steady or have them decline over time.
I recommend performing an expense audit each quarter and comparing your month-over-month expenses to spot trends, money leaks, and excess spending.
I also recommend projecting all forms of cash flowing in and out of your business 90 days in advance. A bird's eye view of your cash flow will help you spot and correct financial problems before they become detrimental to your firm.
Profit is how you keep score in business. How high of a profit margin you maintain clearly indicates your ability to price for profit and control cost.
The net profit margin of a consulting firm should be 25% or higher. The profit margin of your services against your direct cost should be 70% or higher.
If your numbers are below the metrics I just mentioned, I recommend you thoroughly review your service offerings, direct cost, and pricing.
During the daily operations of your business, focus on making decisions I like to call "say yes to profits decisions." SYTP Decisions are selections that will lead to increased profitability and cash flow.
If you examine a decision, it does not lead to an increase in cash flow and profit; it is probably NOT a great decision.
There are additional metrics we can discuss, but the five mentioned will place you on the path to say yes to profits. Monitoring and measuring the financial health of our firm will make building a million-dollar consulting firm predictable and, in many cases, easy.