Why is my profit so low?

When running a small business it can be difficult to see the forest for the trees. You get tied up in a range of activities like attending to client needs, haggling with suppliers, dealing with your pesky tax accountant – you’re “busy”, but none of these things seem to move the needle in your business. A whole lot of busyness without any profit to show for it and you can’t see why.

Sound familiar? If so, I’ve come across a solution that has worked for many professional service businesses over the years and it’s tied up with your single biggest expense – wages.

Quick activity for you:

  1. Log into Xero (if you’re not on Xero yet, you should be)
  2. Run a P&L for the last 12 months
  3. Take your gross profit figure and divide it by your total labour spend (wages, allowances, contractors, super, etc.)

What figure did you get? If it’s over 1.7 or more then you’ve passed the test and you can go home early. If it was less than 1.7 then you’ll want to keep reading.

This magical figure is the return on investment you’re getting from your single biggest expenditure – wages. We’re looking for a 1.7:1 return on this spend. When looking at SME professional service businesses this figure seems, broadly speaking, to work across the board and allows for 60% in labour costs and 20% in overheads to get you a golden 20% on the bottom line.

If you are hitting below this figure it likely means that you’re not getting a great return on your wage spend and your bottom line is suffering as a result. Again, this isn’t a truism, but it does apply to many SME professional service businesses.

What to do about it? It’s time to sit down and review a few things, namely:

  1. Team structure – who you have at what level and what they are being paid?
  2. Charge rates – what rate is each team member being charged out at?
  3. Pricing – are you on fixed fees or hourly rates?
  4. Agreements – are your clients paying for 3 edits or 300 edits?
  5. Productivity – how much time is spent on client work and how much stuck in meetings?

Careful review of the above should give you a pretty clear indication where the problems lie.

If your business isn’t getting a good return on wages and you’re unsure of where to start with this problem or simply want some guidance, we’re here to help. Over many years of working with professional service firms, creative agencies in particular, we’ve developed our Capacity Builder tool.  Using this tool we’re able to analyse your past results and current wage spend, identify shortfalls, uncover hidden capacity and set targets for both your team and your business. The tool is delivered via an interactive workshop and is a simple and powerful way to impact the bottom line of your business. If you’re interested, get in touch today. We’d love to help.