What is your most important business goal? For most of you, the first thing that may have come to mind is “growth.” All MSPs (and all businesses for that matter) consider business growth as their main goal. But before you go allocating more budget to sales and marketing efforts, let’s put on our chief financial officer (CFO) hat and look at the specific financial areas you need to improve in order to accelerate your growth.
This series is designed to help you plan for and achieve success in 2018. Each post digs into a specific department of your business, helping establish a success plan with useful and tangible strategies. In part three, we dove into three helpful strategies for making client satisfaction a driver for your MSP business. In this post, we’ll take a look at which financial metrics you should understand in order to optimize your financial health.
Financial Focus Areas for 2018
As an IT service provider, service is likely your main focus. After all, day-to-day operations and service delivery are what keep your business afloat. Because of this, tracking financial health and metrics can easily get pushed to the bottom of the list. However, it’s time to think about finance more strategically if you want to grow your business and profitability in 2018.
The main importance of finance is to provide insight into the financials of a company. This is critical for both high-level strategic decisions and everyday operations. It’s easy for smaller businesses to simply view finance as bookkeeping and filing taxes, and while that’s important, using the data and insights from finance for more strategic, long-term thinking is equally important.
If you want next year’s graph to be up and to the right, here are some key tips to keep in mind:
- Measure trends – Keeping track of trends over time can be helpful in understanding which areas of your business are improving and which need work to improve.
- Get granular – Using more granular views of profitability—beyond just gross profit—can help identify areas where additional investment or divestment would be in the best interest of the company.
- Focus on EBITDA – Standing for earnings before interest, taxes, depreciation, and amortization, EBITDA is an important figure for a company as it can provide insight into profitability and trends can be used to track improvement. EBITDA can measure the operational profitability of a company, which means that it shows the profit of a company when factoring in the day-to-day operating expenses of a business. To calculate EBITDA, use this equation:
EBITDA = Net Profit + Interest + Taxes + Depreciation + Amortization
It’s important to note that while EBITDA is an essential metric to track, it does not provide a holistic picture of a company’s profitability—other factors should be considered as well.
5 Financial Metrics All MSPs Should Track in 2018
There are many different key performance indicators (KPIs) worth tracking, but to better plan and budget for the year ahead, these are the top ones to add to your list.
1. Gross Margin
Gross Margin provides a high-level view of your total profitability associated with running the business. To calculate your Gross Margin, simply follow this formula:
Gross Margin = (Revenue – Cost of Goods Sold) / Revenue
2. Contribution Margin
Contribution Margin provides a more granular view of your profitability beyond Gross Margin by looking at the profit from a single product or service. Calculating your Contribution Margin can give you insight into which product or service is doing best or which you need to invest more resources into.
Contribution Margin = (Revenue from product or service – COGS for product or service) / Revenue from product or service
3. Customer Acquisition Cost
Customer Acquisition Cost is helpful in understanding how much your company is spending to gain a customer. This is typically used for a specific period (e.g., for one month, $1,000 was spent on customer acquisition and 5 customers were acquired, so CAC for that month is $200 per customer).
Customer Acquisition Cost = Expenses associated with acquiring customers / Number of customers acquired
4. Life Time Value (LTV) of Customers
Because revenue is earned and recognized over a long period of time, understanding the long-term value derived from a customer relationship is critical. LTV can be difficult to calculate, but the easiest way is to use the average profit from a customer per month/year and multiply by the average lifetime in months/years of a typical customer (e.g., if a customer has $1K of profit per year and the average customer stays a customer for 10 years, then LTV is $10K)
Customer Life Time Value = Total Profit expected from a customer throughout their time as a customer
5. Lifetime Profitability
Typically, the LTV of a customer influences how much you are willing to spend to acquire a customer, so you can use LTV and CAC together to determine the lifetime profitability of a customer. Additionally, the breakeven period for a customer is calculated using LTV and CAC, which tells you how long it takes to make back the money spent to acquire a customer.
Lifetime Profitability = LTV – CAC
Overcoming the Labor Challenge
The metrics we listed above are very helpful when thinking about the financial health of your customers and revenue, but what about when it comes to your own team? Many MSPs struggle with the fact that labor is the biggest line item on their balance sheets. So how can you set up your business to grow without hiring new people?
If an MSP is looking to grow without increasing labor, there are three options. The first option is to grow by selling products and services that do not require additional labor. The second option is to increase productivity of the current team in order to grow and increase revenue per team member. The third option is to outsource labor so growth does not cause additional in-house labor to be needed.
This third option is something I think we need to hone in on, because not all MSPs appreciate the power of outsourcing. In fact, did you know that Continuum partners are carrying less overhead to become stronger, more agile organizations? According to an analysis done by Service Leadership, Inc., MSPs working with Continuum were found to spend 6 percent less on average on General & Administrative expenses between 2012 and 2016 than non-Continuum MSPs. These findings illustrate the power of outsourcing labor, and how Continuum partners are able to leverage the company’s on-demand, integrated IT workforce and spend less than their peers on overhead expenses to drive greater profitability.
You’ve just learned about how your peers are achieving greater margins and profitability with Continuum. See for yourself how our transformative platform can do the same for your MSP business!