It’s Time to Focus on Net Income and Profitability

  • September 21, 2020
  • by Jakub Szyszka
  • No comments

If you’re in a hurry, feel free to grab our ✅ key takeaways from this blog post on why net income and project profitability should be a top priority for agencies, software companies, and other professional services firms

Project profitability in a nutshell:

✅ Project profitability is one of the essential business metrics in the digital agency and software landscape. Professional services firms rely on manpower to provide services, hence they’re the biggest asset and cost.

How to calculate net income?

The basic formula is:

Net income = Total gross revenue – Total expenses (including taxes)

which showcases the remaining profit after all incurred costs (income tax, operating expenses, labor costs, etc).

Additionally, we can also use the popular term “bottom line” of a company’s financial statement in exchange for net income as they both describe the same matter.

However, for more complex projects, one can use the profitability index calculation which takes into account the future cash flows from a project or investment.

Why service companies (agencies, IT firms) need to prioritize profit margins?

Agencies and software companies cannot grow without turning a profit on their projects repeatedly. Without predictive, positive cash flow, no investment in staff, and optimized processes can be possible.

To put it simply:

No operating income = No business expansion

Main mistakes that lead to chaos and low net income.

Not having the right tools and processes can make or break your company. At best, provide so much chaos that even management has no idea on the time spent or budget spending (true story!)

Employing the right project management processes and tools.

✅ Using tools without any context or goals will lead you to just piling up subscription fees. You need to use them as a supporting piece to a setup process.

For example, once you decide to implement time tracking processes in order to have a better understanding of your team’s time allocation and performance, choosing the right time tracking tool will be just an afterthought.

➡️ Try TimeCamp for free and start tracking!⏱

So, let’s get started with the full post:

Net income and profit margins – don’t lose sight of them

It seems that making a profit on anything you do as part of your business should be a well-thought process and a must-have factor. Especially when starting out.

We all can agree that the “how I’m gonna make money off of this?” question should be the ultimate decider before starting your next business.

However, there’s always more than meets the eye.

Most project managers, CMOs, and CTOs in modern-day agencies have quite a lot of challenges to face: project delays, last-minute scope changes, tech-related issues, and more.

But, knowing that a business venture is not only generating revenue but most importantly, turning a profit is the essential metric for any C-level executive.

Why it’s still a challenge?

It might seem like an obvious metric, but you might be surprised that creative agencies and software houses still struggle to turn a repeatable profit on their provided services.

Which begs the question:

Running an agency is enough of an operational challenge itself. Besides maintaining profit margins over time, there are also other major challenges in this business landscape.

In this article, you can learn more about what other challenges agencies and software companies face.

A challenge, but not at the beginning

Most early-stage agencies are focused on generating new business. However, once your sales team brings in that new juicy contract, now its time to focus on getting the work done…

Meaning: in a profitable and efficient manner.💵

When does project profitability start to matter?

Agencies and other professional services firms take a deep dive into the profitability of their projects once they’re able to:

1) Bring in new and recurring business.

2) Deliver their service in a timely manner.

Once these 2 absolute core factors are secured, we can state that a company’s business model is finally validated.

For now, you can think of your business as stable.

Kind of…

Now you need to make sure that all of your provided services have a positive impact on your company’s profit.

Net income and project profitability

The struggles of modern-day agencies and software firms are perfectly showcased in Brainyard’s benchmarking research on Advertising KPIs.

Here’s a bit regarding profitability in the agency-model companies of today:

“[…] agencies can no longer rely on lengthy customer relationships with steady work, it’s critical to ensure the projects you undertake are profitable and efficient. It’s vital to track your organization’s profitability as a whole, but to also understand profitability at the client and project level as well in order to make necessary adjustments that can have a company-wide impact.”

And the importance of producing a sufficient profit margin:

“Gross Profit Margin is ultimately the most critical metric to be tracked within your agency. It answers the question: ‘Are we providing our services to customers in a profitable way?’ Pricing in order to maintain sufficient margins is especially difficult in the world of advertising. Unforeseen expenses and changes in client budgets can quickly turn a profitable project into a loss.”

It’s safe to say that today’s digital agencies and software firms are facing more and more competition and general business challenges.

That’s why understanding how to calculate net profitability is essential for sustaining a business.

After all, the bottom line doesn’t lie.

The formula for net income

Well, nobody needs to have a Ph.D. in Economics to know how to calculate net profit margin

Let’s stick with our Econ-101 definition of:

Profit = Revenue – Costs

Having this basic definition in mind, let’s tackle the net income formula to better understand how it impacts your business:

the basic formula for calculating net income

As you can see, this allows us to have a basic understanding of what net income is.

In a nutshell, net income tells us what is the remaining profit after accounting all of the expenses made. Those of which include: operational costs, fixed costs, labor cost, taxes and cost of goods sold (or services).

Small disclaimer

If we account for the existence of fixed and non-operational costs and taxes, then have two new definitions of net profit margin and gross margin.

However, for the purpose of this post, we can skip this and tackle the topic next time.

Other ways

Another way of measuring project profits is by using the profitability index.

However, it’s crucial to state that while it represents the same general idea, it might not be the best fit in our case.

Here’s why:

Another way is to use the profitability index, which is a well-known denominator for measuring future profits:

a breakdown of how to calculate the profitability index of an investment or project

By design, it’s a framework more for assessing whether a potential business venture might be considered as a good investment. That’s why the formula uses the present value of future cash flows.

Professional services firms and agencies mostly charge their clients monthly or by a certain project and once the project is finalized. No significant revenue is generated after the project is finished.

Is this index a good fit?

Of course, for software firms, there are SLA agreements and overall maintenance work to be done, but in most cases, the majority of the revenue is generated within the project’s time frame.

When we place the profitability index in the right context (for example, assessing whether it’s worth investing in shifting to new technology) is still a valid business metric.

So, once we have settled the basics, now it’s time to move from theory territory to the real world.

Why do agencies need to prioritize project profitability?

For agencies, software companies, and other professional services firms, their biggest asset is their employees.

More crucially, they are also the biggest costs.

That’s why being able to assess whether 16 months’ worth of hard work, meetings, feedback sessions, project re-scoping with the client is actually worth it.

A project itself is enough of a challenging endeavor with all of the aforementioned efforts. In that sense, project profitability is the ultimate big picture perspective.

Bad workflow can harm your net income and profit margins

I even experienced company CEOs being involved in clearly operational stuff related to running projects like critiquing design work or other creative efforts.

This approach of course has its upsides because everyone’s on-board to make sure that the company provides quality work.

However, there might be signs of a not fully optimized workflow.

Profitability can make or break your business

In this sort of business model, long-term growth cannot happen without repeatedly turning a profit on all of your projects and accounts.

If an agency is not backed by any venture fund or doesn’t have government agencies to work with where market-driven pricing isn’t as crucial, bringing in substantial profit margins is the only way to:

❗️ invest in better processes to provide a higher quality of service (or reduce the time of delivery)

❗️ hire better talent and invest in upskilling your current staff

Which is crucial for being able to survive in today’s ultra-competitive landscape.

The main mistakes that lead up to chaos in your agency

I’ll start off with a short, but informative story from my own experience.

A little while ago, when I was around 25 and starting my career as a junior biz dev in a fast-paced digital & web agency.

This is 25-year-old me. Pretty much the same, but with slightly worse hair...
Those were the times, young, enthusiastic, and with really bad hair…

I was sharing the same office with the company’s CEO which also was the Head of Sales (and pretty much any other department).

One day, the Head of Project Management storms into the office in a quite dramatic fashion and semi-shouts:

“Steve, we got a $5,000 cost overrun on ADCom’s website project!”*

My boss and company CEO, Steve, made a face like this: 😬

Picture the legendary Michael Scott cringe-grin:

Michael Scott cringe face
😬

Which is in it of itself a very telling reaction.

Question: What sort of agency shenanigan transpired here?

Well, here’s basically a short timeline:

1️⃣ We all worked really hard to win over ADCom as it was a really big account

2️⃣ The project scope (which was an offer contest) was way underestimated (pretty much a standard tactic in the ad industry)

3️⃣ Once the project started, the PM assigned additional junior devs for extra manpower

4️⃣ Being able to precisely track the time spent on this project was a challenge. Although there was a time tracker in place, it was substantially limited in its features and people had to manually switch between processes and projects.

Annoying and not efficient.

5️⃣ There was no real-time measuring of budget goals as well as profitability analysis.

The rest was, history…

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Employing the right project management processes and tools

When dealing with an operational issue or challenge, you need to tackle it from all of the possible angles:

Here’s what you need to do to ensure that your project is actually set to turn a profit:

⏱ Measure the time spent on your project (This is a must. Period!)

There’s no way in hell you can measure your profits without knowing how much time your team spends on all of the projects.

NOTE! That doesn’t mean you have to apply sketchy surveillance software.

🚀Here at Timecamp, we focus on integrating your go-to project management app like Trello or Asana so that once your team goes through all of the user stories or project milestones, Timecamp simply collects the data of how much time is spent on a given task.

🟢Feel free to give Timecamp a try for free and see how you can improve the profitability of your projects.

Easy peasy!

💵 Have a flexible, yet simple pricing model

Of course, if you hire specialists across all seniority levels, it makes sense to charge for their work differently. However, if you don’t have any sort of storage of the implemented hourly rates, your pricing will resemble more like a wishlist.

Yuck!

For example: create a master spreadsheet with all of the expertise that you charge for and assign the hourly rates.

Obviously, you can always adjust these, but make sure that everyone on the billing side is on the same page.

📊 use the collected time data to refine your project estimates for better predictions in the future.

This is crucial…

Let’s say your team estimated that building a mobile app takes 5 months of a 4-person dev team.

In reality, the project took six months.

If you’re diligent with measuring the time spent on this project, you can easily compare the initial estimations with the actual figures.

And this, my dear reader, is the key to optimizing your estimates and being more realistic next time.

Summary

So, to make a clear and easy-to-grasp round-up, here are the final takeaways:

1️⃣ Your project profitability can make or break your services business

2️⃣ Measure it diligently

3️⃣ Use the right tools to collect precise data. (Hint: Timecamp does that! ✅)

If you want to learn how a huge media house mastered the art of profitable projects, then be sure to read the Havas Media case study!

That’s all for today.

What are your thoughts on this matter?

Did your business face similar challenges when trying to calculate net income and turn total revenue into actual operating profit?

Let us know in the comments!⬇️

PS. Oh, and of course, the names used in that agency story are changed 😉

Jakub Szyszka

Content Marketing Specialist at TimeCamp. Passionate about being another frustrated musician ;) Most recently immersed in the adventurous world of content marketing and brand building.

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