The second stage of the Life Cycle of Agencies framework is Build Mode. You’ve made your first million; now, how do we grow that one million to three million?
(By the way, if you haven’t quite hit your first million in sales, learn how to grow your agency to its first million by jumping back a stage in the life cycle framework to Create Mode)
Entering this stage is the first major inflection point for an agency. Growth through brute force is no longer enough as the owner runs out of energy and time to wear every hat. Success requires building a small leadership team and a change in thinking from “Let’s build an agency” to “Let’s build a profitable agency.”
Financial management should be focused on moving through the hierarchy of financial needs and mastering capacity management and repeatable revenue generation.
Let’s jump into it. We just threw out the phrase “hierarchy of financial needs” - what the heck is that?!
The hierarchy of financial needs is a way to approach our financial KPIs sequentially, treating them as stage gates - meaning you don’t think about the next stage until you’ve cleared the stage you’re currently in.
The first step of the hierarchy is solvency. Can you make payroll next week? If you have a solvency problem, your answer to that question is probably, “Well, I don’t know!” You can’t convert an opportunity into a sale, then invoice, and collect cash quickly enough to make payroll next week, so the sales pipeline shouldn’t be your focus here; it should be solving the problem at hand. What can I do right now to get cash?
The second step of the hierarchy is project profit - aka gross margin. Gross margin - without us giving you a big accounting lesson - is your AGI (net revenue) less your costs of goods sold. It’s the profit you make on your core service. Every agency is different, so beware of the blanket benchmark, but in general, we like to target a gross profit of around 50-60%. If we’re meaningfully below this mark and have what we call “a gross profit opportunity,” we stop and diagnose the cause. It’s likely to be one or both a utilization problem and/or a pricing problem. Once you’ve sorted this out, it’s time to move on to the next step.
The third step is cash reserves - saving enough cash to sustain the business through the highs and lows of project-based cash flow endemic to most agencies. We like to target three months of fixed operating expenses in the bank as our cash reserve. If we don’t have that - that’s our “nothing else matters; we have to focus on this” point.
The fourth step is net profit. What’s our profit after paying for our fixed overhead operating expenses? We like to target 20%. Once you’ve reached about 20%, you’re ready for step five.
The fifth and final step of the hierarchy of financial needs is predictable revenue growth. While revenue through referrals is great, we rarely see agencies eclipse $3 to $4 million in revenue without a revenue-generation engine.
Once you’ve cleared the steps of the hierarchy, your agency will be ready to move on to the next life cycle stage. Don’t rush out of build mode; focus on each step of the hierarchy and build a solid foundation for your agency to live and grow on.
For an additional conversation surrounding this stage of the life cycle framework, tune into EA Live where Upsourced’s Ryan Watson is interviewed by an agency owner to discuss what it’s like going through Build Mode.
Also, check out our podcast: Creative Outcomes.