David Baker – Performance Metrics
1. Common reporting mistakes in Creative Agencies — this is for financial reporting, items that will make your financial rations inaccurate.
Late Statements – should have complete statements by 10 days after the closing of the month. No excuse for this not to occur. This may not be your fault. In the past, all you had to do was wait for the bank reconciliation. If you don’t have the data, here are the reasons why:
Too many people involved
Too many exceptions based on unique client arrangements
You don’t have enough labor
Capturing Long-Term Liabilities — need to capture all long term liabilities that you couldn’t get out of except for facility lease.
Separate the current portion of the Long-term Liabilities — defined as the next 12 months of payments.
Reversing Loan to Shareholders — you report things to account for transactions for tax purposes. But for financial health, this data makes the picture unclear. Makes the company look like they have a significant asset when it doesn’t. You need to recognize this fact when running ratios, but still keep them on the books.
Defining Cost of Goods Sold — if you are using benchmarks, then it is defined as an outside expense and must be tied specifically to a project. Both of these must be true.
Reflecting Depreciation — not updating it at all or not reflecting it in both statements. You should update these totals once a quarter.
Work in Progress/Client Depreciation — you need to recognize unearned income as a liability — do not pay tax on the income until you have earned it.
Reversing Goodwill — if you purchased another company, this is the difference between what you paid versus what it is worth. Within analysis, remove this figure.
a. Be Accurate
b. Don’t Read Too Much into Short Periods
c. Pay Attention to Direction, Not Speed – don’t manage the company based on cash flow. You want to eventually manage the firm by balance sheet as opposed to income statement. Use the analysis to assess the impact of the decisions you’ve made over the years.
d. Look at the Whole Picture
e. Distinguish Between Types of Profit – use the word sales instead of revenue or income. Sales less COGS is AGI = Agency Gross Income. Not Adjust Gross Income. AGI less overheard is Net Income. Distinguish between AGI or Net Income. All ratios are based on these two figures. Only one goes to sales.
f. Use common size percentages against AGI –
g. Measuring against ourselves – to review your own progress
h. Measure against others
a. Monthly Overhead – need to look at this, and look for trends. Need to know this off of the top of your head.
b. Months of Cash – if your overhead figure is x; then how many months do you have cash to pay it? Two. This is REAL MONEY not receivables. This assumes you do not have a client concentration issue. Remember that too much money is a problem.
c. Collection Period – calculated by total sales (only ratio using sales) and divide by 12. If more than 45 days you have a collection issue.
d. Payment Period – traditional wisdom is to stretch out payables. Truth is that it is immaterial. Pay them as soon as you get the bill. Allows you to ask for favors.
e. Debt/Asset ratio – aim for .2 and .6. All debt/All assets
f. Equity – need to track. Least useful at the end of the year. Also least useful balance sheet — because of adjustments.
g. Current Ratio – Current Assets/Current Liabilities. Needs to be 1:2 ratio of current debt to current assets.
h. AGI – review this for revenue growth. Most people like sales, but this assumes that the ratios of outside costs have stayed the same.
i. Client Concentration – up to 25%. Calculate this with AGI (client AGI compared to total AGI) and by taking all related clients and grouping them together. But you lose a big client because of vendor consolidation or someone else buys the company. If you cannot take this loss then there is another problem. Red light comes at 35% because if you look at evidence of firms over time, 1/2 go out of business when this happens. Not immediately but when they look at themselves historically, this has occurred. If you have a client that represents less than 5% then there is a diminishing return assuming they are giving you all of their business. You are not making an impact on them.
j. AGI Billings/FTE Employee (full-time equivalent employees) – Divides AGI by number of employees. Two part-time equal 1 Full-time. This is something to monitor this over time. Average is around 90,000. Use Annual Sales.
k. Salary Load – Maybe the simplest; maybe the most important. Calculated against AGI. Should not exceed 45% of AGI. Doesn’t include taxes or benefits. Use salary only. Does include normalized compensation for a principal.
l. Facility Expense/Size – 6% of AGI is the benchmark. Should include monthly payment (lease, etc), heating, water, utilities, cleaning, security, insurance for facility, local taxes of any sort. How much space do you need? Lower limit is start with 100 sq. ft plus 200xFTE employees . Upper limit is 500 plus 250xFTE.
m. Operating Profit – 15% is a bear minimum on average assuming normalized compensation for principals. 1-4 employees is 100k, (couldn’t type fast enough for 5-13) 14-16, 240k, 17 and over is 275k. Compare what a principal makes to what they would make elsewhere. This is the price you pay to be in control of your own destiny; and you take on all of the risk.
n. Utilization – add up employees and hours they work, 60% should be captured financially.
3. Cashflow Management – A simple plea: cash flow issue is fleeing, by definition. If it regularly happens, this is a profit issue. A much bigger problem. If you try to solve a profit problem with a cash flow solution, you won’t fix it. Example: working for client that shouldn’t be in your agency.
Real Cashflow is a Symptom, not a Disease, Caused by Seven Other Things
a. Insufficient Cushion
b. Overreaching Growth
c. Client Concentration
d. Collection Difficulty
e. Inappropriate Overhead
g. Poor Financial Reporting
4. Management Software
Workamajig is the least evil marriage partner – hard to recommend a program on a large scale that works for everyone.
Appropriate Expectations – define what they are and manage to them. Problems are cultural in your business environment. If people don’t cooperate and use it, it won’t work.
Provisioning on your part
Role (After Culture is Established)
5. Funding Growth
Fixed Obligations – avoid entirely when you can unless it is an appreciating asset. Why?
Paying with Cash
Use cash to pay for things, it helps you spend less. Good example: buy you dinner tonight with cash and compare what you would spend to last night’s credit card bill. This idea helps you grow more slowly. If you allow growth to “happen” to you, this is a bad decision. If you use cash that you have to invest in more employees, then you will make better, more realistic decisions that will last.
Helps you survive in a downturn
Helps you face operational difficulties – if you don’t have cash for what your agency needs there is a problem. If you don’t use cash then you are masking this problem.
Not Cheaper if the Company Pays for it
Don’t get a 30% discount on something you don’t need
Author’s note: Do yourself a favor and visit David’s Position Papers!