The Profitability Equation.
First, let’s agree to this. You’re agreeing you actually want to be profitable, right?
As Bill notes, “If you don’t accept the perspective of “You deserve to be profitable,” then you’ll probably give it away. Now that we’ve gotten that straightened out, let’s go.
1. Figure out how to be profitable.
First, you have to do a budget.
What does it cost you to be in business? For this equation, let’s assume we’re dealing with a one-month timeframe. Most of your expenses are billed monthly, so this should cover most things. Your budget will include things like electricity, internet service, phone line, advertising, your salary (yes, you get to decide what to pay yourself), heat and office supplies. That’s your monthly operating expense. That’s what you have to earn to break even.
Next we get to decide on the profit you want to make. You simply add how much you want the company to profit to the operating expenses. This is the total that you need to bring in each month.
Now, how do you figure out how much to charge to accomplish that goal? Simple, you need to figure out how many hours you can bill your clients each month. A safe bet is about four hours a day per employee. This may not seem like much, but remember all the things you have to do each day — answer phone calls, write estimates/proposals, design advertising, deal with freelancers, invoice customers, email files to the printer, etc. At the end of the day, you’ll see that four hours a day of billable time is a reasonable goal. Now we multiply that times five to get 20 hours a week times 4.3 (average weeks in a month) to get 86 billable hours per month.
The last step is to divide the total you need to earn by the billable hours you can work.
Simply writing out a math equation on a piece of paper won’t make you profitable. Writing down a salary of $90K in this equation will not make it come true. But this is a handy little way to think through what you’re charging, how many hours you’re working, and if you’re not profitable– why.
2. Write up your business plan.
Writing a plan is a great way to get your brain to start thinking about all aspects of your business. If you don’t write a business plan, it might not occur to you to consider how much money you have to pay to Social Security as part of your payroll and you might not consider what will happen if your company scales up quickly. Maybe your office is only big enough for two employees. What happens if you suddenly need to grow in year two? You should be thinking about where you expect your business to go, and develop plans for that.
But — and here’s the important part — a business will rarely go as planned, so it’s important to not get tunnel vision. When things start to go in directions you weren’t expecting, you need to be agile and flexible. You need to be able to identify opportunities and run with them. Also, you need to recognize quickly when something isn’t working and make a dramatic change if necessary, and quickly. I suggest writing the plan because it’s an important learning tool. By mapping it out, you’re setting goals and expectations. These are benchmarks that will allow you to make comparisons. You should invest real energy on it.
3. Pay yourself as little as possible.
Obviously, your payroll as owner is an expense to the company. It must be budgeted just like anything else. If you pay yourself too much, you’ll soon find yourself broke. So, for the benefit of the business, it’s important that you pay yourself as little as possible. At Go Media there have been many years where the partners paid their employees more than we paid ourselves. Occasionally when we’ve fallen on extremely hard times, the partners have skipped payroll.
If you have a day job and are considering starting a design firm — Don’t quit your day job. Hold onto that day job as long as possible. That’s income. That’s your first client! They might be a bad, low-paying client, but they’re still your only source of income. Go to your day job, then work on your business at night. Spend as much income from your day job as possible on your business. When you start landing clients, do that work at night and on the weekends. You should only quit your day job when you’re so slammed with work from your business that it justifies quitting.
Oh, and if you feel like you don’t have the energy to work on your own business after you’ve worked a full day at your regular job, you might seriously consider how committed you are to building your own company. Starting a new business requires more than eight hours a day.
5. Stay in business.
It doesn’t have to be pretty or comfortable. You don’t need a fancy office or a catering service to bring you lunch. Staying in business means you have electric for your computer and a working phone line. If your idea of being in business means that you have fancy desks, embroidered shirts and a big neon sign, you need to adjust your expectations because things may get tough — very tough. And when they take away your neon sign, If you think you need it to be in business, then you’ll probably quit.
6. Avoid borrowing at all costs.
As outlined, frugality is key to survival in the early years of your business. You want to make it as difficult as possible to spend.
Borrowing does three things. First, it takes pressure off you to sell! If your rent payment is coming up and you have no money in the bank, guess what — you are going to feel a ton of pressure to go sell something. That’s a very good thing! Second, borrowing money makes it easier to spend. As mentioned previously, frugality is key to survival in the early years of your business. You want to make it as difficult as possible to spend. Third, borrowing money puts you in a worse financial position and saddles you with interest payments as well as possible emotional debts. Owing money to your family can be a terrible burden to carry.
“But Bill!” you say. “It does take some money to start a business. If I don’t already have it, how do I get it?”
7. Buy only on need, not want.
It’s simple. Only buy equipment based on need, not excitement. If possible, hold off on buying equipment until you can justify its purchase in the cost of the project.
One word on technology, I’ve always been quick to make investments in technology and equipment. If some technology or equipment can make your company run more efficiently, I recommend making the investment. If you’re uncertain about the ROI of some new technology or equipment, you can easily do a quick cost vs. benefit analysis. Generally, a design firm’s wages are by far the largest expense. Anything you can do to maximize the efficiency of your staff is typically going to be a winner. I do like to hold off on buying equipment until I’ve landed a project that justifies the purchase.
8. Get slammed. Then raise your rates.
Work hard until you’re slammed, raise your rates, repeat. This is what I did over the first few years of my business. My logo design pricing for instance, went from $300 to $500 to $900. But I was holding steadfastly to my flat rate, upfront pricing system. Admittedly it was becoming more difficult. A customer would ask for a logo design, I would quote $900 and they would say: “$900 ?!? But I already did a sketch. I just need you to refine this letter ‘C’ I made. It should be very simple. Really? $900? That doesn’t seem fair.” In this scenario it would have only taken me a couple of hours to do what the client was asking for; that wasn’t fair. A flat rate system just didn’t seem to account for the variables in design projects. One price didn’t fit all cases.
More than anything, remember to keep the faith. Go Media was not an overnight success. Money was terribly tight for at least the first five years. Remember that as long as you are in business, you’re being successful. And so long as you’re learning, given enough time, you’ll eventually figure it out.
Be sure to check out Bill’s new book, Drawn To Business, ‘a transparent look at how Go Media and other top firms built their business from the ground up.’
This blogger graduated from Goldman Sachs’ 10,000 Small Businesses program. Goldman Sachs is a partner of the What Is Working: Small Businesses section.
Follow William A. Beachy on Twitter: www.twitter.com/william_beachy