It is useful to simplify and de-mystify processes that are prone to confuse or intimidate, frustrate or overwhelm. Stripping complex processes down to their basic ingredients allows a clear picture to emerge and reveals how the gears and levers really work. It is then easier to understand how to build out, alter, or sustain as needed. A recipe (or formula, if you will) can de developed and codified.
Just like your favorite cookie or potato salad recipes, there are recipes that can be used to develop a profitable business enterprise. Let’s look this profit-making ingredient list:
That is, prospects. Those individuals who consider doing business with you. You may meet them in person anywhere and if they pose serious questions about your business that seem to make follow-up discussion appropriate, then consider that person a prospect. If someone visits your website and pages through in search of information about your products and services, those visitors are also prospects.
Prospects who do business, whether they purchase a product or sign a contract for your company to provide a service.
AVERAGE DOLLAR SALE
You can calculate the average sale on a monthly, quarterly, or annual basis. Divide the accounts receivable amount by the number of hours invoiced.
AVERAGE NUMBER SALES
Depending on your business, you may have only two or three projects in house at a given time. Intangible service providers often have bigger ticket sales (projects) that are fewer in number than tangible service or product providers.
This metric will be much easier to determine in a retail business, where wholesale acquisition costs or product production costs are readily verified. Service providers must estimate their wholesale cost to produce that which is sold to clients. If you provide graphics services or shoot videos, what does it cost you to provide the service? That estimated amount will be deducted from the hourly or project rate that you bill the client and that will reveal the profit margin.
- Leads X Conversion rate = Clients
- Clients X Average Dollar Sale = Revenue
- Revenue X Profit margin = Profit
Consider this example. In your business, you, your newsletter or blog, social media accounts and your website make contact with an average 20 leads a month and you manage, on average, to convert one in every five of those prospects into a paying client, giving your organization a 20% conversion rate.
Leads (20) x Conversion rate (20%) = Clients (4/month)
A reasonable estimate of the wholesale value of your time —-considered your production expense—to provide one of your services is $40.00/hour. You typically bill at $65.00/hour, meaning that your hourly net income is $25.00/hour.
To calculate your profit margin, determine the amount of revenue (before deducting expenses) that your business earned during the calculation period. For this example, we’ll have you bill those four clients a total of 100 hours/month, as 25 hours each per month, invoiced at your usual $65.00/hour for a total of $6500.00 gross revenue (sales) earned monthly. You invoice each client $1625.00 a month. Your $25.00/hour net income amounts to $2500.00 in a typical month.
Clients (4) x Avg. Dollar Sale ($1625) = Revenue $6500.00
The profit margin is calculated by dividing the monthly net income of $2500.00 by the gross monthly revenue (sales) of $6500.00 to reveal a monthly profit margin of 38.46%. The profit (in contrast to either gross or net revenue) is calculated by multiplying the profit margin of 38.46% X the gross revenue (sales) of $6500.00, that equals $2500.00/ month profit. You may recognize that figure as your monthly net income!
Revenue ($6500.00) x Profit margin (38.46%) = $2500.00
So there you have it. As you can deduce, proprietors of service businesses that see few clients each month can, after doing research that helps determine a reasonable wholesale cost of your labor when providing services, can really impact profit by appropriately pricing services offered. An increase of just $5.00/hour will add $500.00/month to the four client, 25 hours/month per client, total of 100 hours/month scenario presented here.
You’d invoice each client at $1750.00 per month, rather than $1625.00, and your monthly gross revenue (sales) would be $7000.00, a nice improvement over $6500.00/ month. To account for the inevitable fluctuations in Freelancer earnings, I estimate that for 10 months/ year one can reasonably expect to earn at the projected level shown here.
Thanks for reading,
Photograph: © Girl Scouts of America, circa 1960