Getting a handle on your agency’s finances (featuring Jon Morris)

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Chip Griffin: Hello, and welcome to another episode of Chats with Chip. I’m your host Chip Griffin, the founder of SAGA, the Small Agency Growth Alliance. And I am delighted to have with me today, Jon Morris, the CEO CEO of Ramsay Innovations. And I was joking that your name was so easy, but apparently I cannot say CEO to start a show.

So, but that’s just, we keep it real here on Chats with Chip. So welcome to the show, Jon.

Jon Morris: Yeah, thanks for having me, really excited to be here, Chip.

Chip Griffin: It is great to have you on but before we get started with our conversation, why don’t you just share briefly a little bit about yourself and Ramsay innovations?

Jon Morris: Absolutely. So name is Jon Morris and prior to founding Ramsay Innovations, I actually founded a digital agency called Rise Interactive. I grew it from just me working out of my home to about 250 employees. Sold it to Quad Graphics, which is the largest printer in the United States, uh, and stepped down as CO 2 years ago.

And when I look at the success of Rise, a lot of it had to do with the financial acumen that we built. And so what I’m doing now with Ramsay Innovations, Is teaching smaller agencies how to build a world-class financial infrastructure and helping them implement that. And that entails everything from what I consider the table stakes portion of your finance department, the accounting group, which is paying your bills, sending out your invoices, doing the payroll, all of those really important things, to more strategic, putting your budgets and strategic plans together. Forecasting, cashflow analysis, emergent analysis, and giving you insights to spend your time and money more efficiently, more effectively.

Chip Griffin: And those are critical skills that, I mean, really every business needs to develop, but particularly small agencies as they’re going through their growth stages. So I think it makes for a good topic. And I know, it’s something that a lot of agency owners are interested in learning more about, and the fact that you can bring the experience as an agency owner to the table, to the financial mix is, is really helpful.

So let’s go ahead and start diving into some of that if we could. And as you’re, as you’re sitting there wearing your agency owner hat, you know, what are the, the most important things that you need to be keeping track of from a financial perspective? What are the, you know, the three or four key reports or metrics that you think almost every agency owner should have at the tip of their fingers as they’re making decisions.

Jon Morris: So I’m going to answer that, but I’m also going to let you understand that every single agency owner has a strategic plan, whether they know it or not. It is what they choose to spend their money on. A real life example: I had a prospective client two weeks ago. They were telling me how important growth is to their business.

And so I asked them a simple question. What percent of your revenue do you spend on sales and marketing? And the answer was zero. And so what I explained to them and I was like, look, the cool thing about what you spend your money on is it really prioritizes what is important. And so in that scenario, I said, growth is really not that important to you.

So one of the metrics that is most important to me is what percent of your revenue do you spend on sales and marketing? If you want to grow, could you grow? Like, could you be an amazing founder and be an amazing salesperson? Yes. But generally you’ll hit a wall in terms of the amount of new business you can bring in versus the amount of new business or amount of existing business that you lose.

And you hit a plateau point. Fueling sales and growth or sales and marketing is a really important number. Probably the most important metric though, is your gross margin. And let me explain what I mean by gross margin, because I have to define a few things. The first thing is I have to define revenue. When I say revenue, I break revenue up into two types of revenue.

There is gross revenue and there is net revenue. Gross revenue is including all of your pass through items. So like your media spend. Or any technology that you pass onto the client. And when all that pass through is gone, you get your net revenue. Then we have something called cost of service, costs of service are all of your employees, the technology, travel and entertainment.

Anything that you spend to do client work goes into that cost of service bucket. And what you have left over is your gross margin. Most agencies in the smaller size do not know what this number is. And it is by far the most important number to know. What we want as a benchmark is 50%. And I’m going to give you another real life example of two agencies, both around 5 million in revenue, both do the same services. Both are in the same market. Both have the same type of customer. One of them generated a million and a half in profit last year. One of them lost $400,000 last year. The only difference really was the gross margin. One had a 60% gross margin, one had a 19% gross margin. So understanding that allows you to make really intelligent decisions.

Chip Griffin: Yeah, I think those are great points there. And, I think let’s start with the gross margin piece, because I think that is something that most agency owners, at least in the small agency space don’t know. They don’t know it at the agency level and they certainly don’t know it at the client or project level.

And I’m a big believer in, you have to know it at that more granular level as well because…

Jon Morris: Client, project, and service level.

Chip Griffin: Yeah, because otherwise what you have is you typically have some, some particularly lucrative and I don’t mean high revenue, but high profit clients projects or services that are subsidizing a lot of the other things.

And so if you’re not looking at it in a more granular way than you’re potentially masking real problems in your business, and you’re not focused on the right things, right. Because when you’re defining your ideal client, you want to get more of those high margin clients. Those are the ones you want. You don’t want the ones that you’re just, you know, eking out and doing your best to do.

Jon Morris: Can I actually give you a great example?

Chip Griffin: Yeah, absolutely.

Jon Morris: That company, I was just telling you about that made a huge profit and had a 60% gross margin. Everything sounds really rosy, but it turns out that one service offering is subsidizing all of the other service offerings. And so they actually have two core service offerings they’re losing money on right now.

Their expenses are greater than the revenue being generated. And then when you break up the service where they’re making a ton of money, they have two ways that they categorize it. And one way is 70 to 75% margin. And the other one, they actually have a person on the team with only a 12% profit margin for their book of business.

And so when you get into these granular layers, think about how much more money that company can make, even though they’re already making a ton of money. And so we’ve recognized that they’re, they’re leaving about a million dollars a year on the table with their existing team by not maximizing the employee utilization and the hourly rates that they’re trying to realize.

Chip Griffin: And I think a lot of this comes from the fact that the agency owners have been conditioned from a lot of what they read to focus on the wrong financial metrics. And so they think about top line revenue. Oh, I’m a million dollar firm. I’m a $5 million firm. Those things mean nothing. Particularly if you do have a lot of those pass through or reimbursable expenses like media, like technology and those kinds of things, because you can have a really, really high top-line number and a miserable bottom line number. You cannot do anything with that top line number except brag about it, perhaps to your peers. Right? You cannot go cash that top line number.

Jon Morris: Yeah. And that’s another thing is I try to explain it to a lot of people, their business is valued based on their profit or specifically their EBITDA.

And so we typically want agencies to come in around 20% EBITDA as a percent of their revenue. When I say EBITDA for those listening it’s earnings or think of earnings as the word profit before interest on any loans, taxes, or if you have any capital that you’re depreciating or any software that you’re amortizing.

And so it stands for earnings before interest tax, depreciation and amortization.

Chip Griffin: And importantly, I think it’s important for owners to understand that they have to assign themselves a fair level of compensation before they calculate that 20%.

Jon Morris: Absolutely.

Chip Griffin: Because that particularly, if you’re an agency of say, you know, two, two and a half million or less, your compensation can be a huge percentage of your profit, if you are not calculating it correctly. And so it can cause wild swing. So how do you counsel your clients or just any agency to, to assign a fair value to the owner’s compensation? Because obviously for tax purposes, there may be a variety of different ways that you want to do it to minimize your tax burden, but that’s not a real health of the business type analysis.

Jon Morris: I’m a huge believer in third-party compensation analysis. And there are a bunch of companies that provide this data where what you want to do is if you’re a $2 million agency, you want to ensure that everybody’s paid market rate. And so, and I’ll go into what is market rate. So what they’ll look at is your role, the size of your company, the industry in the market that you’re in.

And they collect all sorts of data of, you know, if you’re a digital agency in the Chicago land area, you know, this is typically what a CEO gets paid, and that’s what you should be looking at as the benchmark of what you should be paid. And it generally comes in a range. It’s not like a specific dollar amount.

It’s like a 25% to 75% range of what you get into. And I try to get base to be on the lower side. But the total comp to be on the higher side based on performance.

Chip Griffin: Right. And there’s no reason why you shouldn’t be able to, you know, get a healthy level of compensation out of your business through a variety of different levers.

But you need to know when you’re calculating that EBITDA, because it is the benchmark for how you can really judge the health of your firm and, and all that kind of stuff is you’ve got to come up with those fair numbers. And so, you know, in addition to doing sort of third-party compensation assessments, which I think is very helpful.

You know, some of the other advice that I give and I’d be interested in your perspective on this, you know, make sure that you are the highest paid employee. Oftentimes I see owners pay themselves less than people who are substantially more junior in their own firms. That’s a warning sign.

That’s a red flag that you’re probably not assigning yourself fair compensation. And the other is, think about, you know, what would it cost for you to hire someone to come in and do the vast majority of what you’re doing on a day-to-day basis?

Jon Morris: Couldn’t agree with you more. So, first of all, I have a general rule that, you know, your direct report should always make less than you and that whoever the next person’s direct report should make less than that person.

Like, you’re going to run into a compensation problem if you have direct reports who make more than their boss. And so if you follow that rule. I’ve also read 50% – you take the highest person, highest paid person and times it by 1.5 and that is a good target for a CEO compensation.

Chip Griffin: Yeah. And I think that, you know, if you have no other numbers to go off, I think that’s a great place to start because, you know, more often than not I see owners who are under compensating themselves, at least on the P and L. They may be doing just fine, you know, once they start taking draws and things like that, but you, that’s not really helping you to understand how your business is growing.

Jon Morris: Exactly. What you have to do is you have to like, you know, for example, if you’re an LLC, you don’t pay yourself a salary, right.

It’s just your salary and your profits are synonymous. But in your budget, you want to actually put in this is the compensation for my time. And then this is what my owner’s draw should be based on me just wanting to take cash out of the business. And it’s very important to have a distinct. Like distinguishing the two.

Chip Griffin: Yep, absolutely. And so it often means that you have to have effectively two sets of books, right? I mean, it doesn’t, it doesn’t mean you have to have a lot invested in that. Right. But you do need to have the two sets of numbers, one that you’re using for tax purposes and one that you’re using for measuring the progress of the business towards your goals.

Because they do serve different purposes. And if you’re not doing that, then chances are, you’re either paying too much in taxes or you’re not learning enough about how the business is running.

Jon Morris: Well, the other thing is there’s something called cash versus accrual accounting. And when you do your taxes, you’re going to want to do it on a cash basis.

That’s when the cash actually comes in. So good example, if you win a contract and it’s for $50,000 a month, but they give you a check for $600,000 in January, cash would show you $600,000 of revenue in January, zero for February through December. Accrual is basically when you actually do the work. So if you’re a 50,000 a month, you would show only 50,000 in January, even though the cash came into that time period.

And for the listeners here, it is absolutely crucial that you measure your business on accrual method because that’s the only way you get real insights into how your business is doing at a specific given period of time.

Chip Griffin: Right. And, the fact that most agencies use cash based accounting, and don’t even bother with the accrual, even for measuring the health of the business.

That’s why there’s this, I think misperception that agencies are constantly in feast or famine, right. And it’s not that they’re in feast or famine. It’s that their books look like it because of these irregularities, in terms of when people are paying, you know, they may pay upfront for certain work. They may be slow to pay on certain things.

And so, you know, from a cash basis, you’re going to see that rollercoaster. In your revenue in all likelihood, unless you’re just, you know, getting all electronic payments once a month for everything you’re doing, but how many businesses do we know that are that rhythmic about that. But accrual evens that out.

And so now you can start to see the real trends and all of a sudden it’s not feast or famine. It’s just that you have to manage your finances a little bit more directly.

Jon Morris: Couldn’t agree more. Now I would even just say just another comment about, you know, people running it on a cash basis. A lot of people who start agencies are not necessarily entrepreneurs. They are marketers and they have a specific expertise in marketing that they want to share. And they feel like, Hey, by starting my own business, I can do it my way. I can provide a better service that wherever I was before. But finance isn’t, I get the core of their expertise.

But what I always explain to people is there are two versions of you. There is the CEO version of you, and there is the marketer version of you. And if you want to build a big company, you have to recognize that you’re, you’re moving out of the marketer, you’re moving into the CEO role. And that just happens to do marketing.

And if you’re going up against your competition and they are investing in their financial infrastructure, and they’re able to answer questions and get insights that you’re not, you’re putting yourself at a huge disadvantage. And what you want to do is you want to be the opposite. You want to be the one that has all the data structured really intelligently to answer questions that nobody else is answering so that you spend your time and money more intelligently.

And that’s one of the most important things about why you want to build your financial infrastructure.

Chip Griffin: Well, and I think it’s, it’s not even necessarily about wanting to grow a big business. It’s any time you want to go beyond just yourself in the business. So as soon as you hire a single contractor, you need to start understanding the finances of the business.

And running it like a business as opposed to running it like, you know, I’m just picking up freelance contracts. So I’m more like a, an independent employee. As soon as you’ve got other people you’re paying, you need to understand how all these things work. Otherwise you’re going to end up working harder than you have to, to make less than you should.

And that just doesn’t make any sense.

Jon Morris: Couldn’t agree more.

Chip Griffin: So let’s go back to your, the first point you were making in terms of you are essentially speaking to your priorities by how you’re investing your resources, and you were talking particularly about finances. I would also make clear to folks that you need to understand that your time, the time of your team is part of that.

Right? And a lot of times agencies forget to account for the fact that you know, that the time that I’m spending as the owner or that Sally or Johnny are spending as team members on a particular activity, that’s an investment. And it doesn’t matter whether they’re investing in a client project or sales and growth or whatever, it’s a, you have decided that this is a priority because that’s how they’re spending their time. And you need to understand that and make sure that you’re getting a good return on that investment. So let’s, let’s zero in on that a little bit, to understand, you know, where maybe some small agencies might be going wrong and could do better. And so how do you start to think about, well, first of all, let’s, let’s talk about time tracking because I think that’s, that’s core to what I’ve just said.

And. How important is time tracking and you know, how much do you need to, or how complex does it need to be in order to give you what you need, in order to make intelligent investment decisions.

Jon Morris: So I want you to think about when you go to the bar and you order a shot and they had that little measuring cup where they pour the drink into the measuring cup, and then they pour it into your drink.

And they do that to ensure that they get as many shots as they can out of that bottle. And when they don’t do that, And you’re just trusting each individual bartender to pour the drink based on what they believe a shot is, there’s a lot of inefficiencies. And that’s the same as how I would view time tracking.

What you’re looking to do is gain insight into the profitability of the services you’re offering, the profitability of your clients, the profitability of projects. If you do not time track, it is going to be incredibly hard to do that. Now I understand time-tracking sucks. Okay. Nobody enjoys it, but guess what?

Chip Griffin: Oh, come on! I love it, John. It’s fun.

Jon Morris: Okay. The people who own Harvest really enjoy time-tracking. Yes. But you know, the other part that people don’t understand. It is a critical element for resource planning. You know, there’s two certainties I believe that exist in the agency world. One certainty is every year your employees want to get paid more and they want to work less.

And the second certainty is that the client wants to pay less, have you work more hours and talk to more senior people and you as the agency owner are stuck with the bill. And if you don’t time track and your employees want to work less, but the opposite happens, they end up getting burnt out because you don’t know how to staff, when to staff, how to staff accordingly.

So I believe it is beyond a critical element to answering really critical questions. I can tell people oftentimes like, Hey, you’ve got a gross margin problem. But if I can’t get into the why you have a gross margin problem, it doesn’t help that much. All we know is we’ve got a problem. I can’t tell you if it’s because of client A or client B.

I can’t tell you if it’s because of service A or service B. And I can’t tell you if it’s because of project A or project B. And the other thing I can’t tell you is it might be a scoping issue on a specific task. Now you asked me how complicated it should get. And my answer is as least complicated as possible.

What happens is if you try to do time tracking in overkill, where you’re not just tracking the client, the service, the project, the task, but then you get into the sub and the micro tasks and you keep on going further down. Your adoption rate starts falling because it’s just too hard for the employees to keep up.

Yeah. So I’m very big on the user interface, and trying to make it so that you can get time entered into the system as fast, as quickly as possible. I’m very big in trying to track as few things as possible. So that someone doesn’t have to do massive amounts of data entry into it, because that’s where your adoption starts to fall.

Chip Griffin: Right. And I, and I think that’s where most agencies get it wrong. They go to one extreme or the other, they say, look, you know, we’re throwing out time sheets. It’s an antiquated way of doing things. You know, we’re not going to burden you with that. We want you to feel good. Or they go into, you know, I want to know every second of the day exactly what you’re doing.

And they collect all this data that not only is burdensome for the employee, but they never end up using. It just sits there on Harvest or whatever platform you’re using. And so, so now you’ve made the employees’ lives miserable for no good reason. And so I’m totally on board with you. You’ve got to get collect the least amount of information that you need in order to make those critical decisions.

And, if you do that, and I think the other thing that you mentioned there, it helps you with resource planning so that employees don’t get burned out. You have to explain the benefit to the employees of why time-tracking matters. You can’t just make it seem like your Big Brother trying to creep on what they’re doing.

You’re doing it because it can help you figure out when they’re overworked, when they need help, how you can invest better. And if you do that employees, you know, they’re not going to love time tracking, but they will at least understand it better.

Jon Morris: And you need to tell them it seven times and in seven different ways. It takes a lot for change management.

It takes a lot for them to be ingrained and to get on board. And the only other thing that I would say is before you get into time-tracking start with the question that you want to answer. And then when you figure out the question you want to answer, then think of the template that you’re going to create that’s going to answer that question. Then think of the data sources you need. Okay. So if you want to understand, you know, margin by client, well, there’s a lot of different data points you need. So the first thing is you need to know who works on what client. Then you’re going to have the person who works on multiple clients.

You’re going to have to figure out what do you do with those people. You’re going to have to get the payroll information so that you could assign it properly. And then you actually get to get the time data to figure out what people were actually spending. So then when you figure out that time data component, now you can start thinking, okay, well, I know that in Harvest, I need the time data to look like this, you know, But if, if that’s the only question you want to answer, you’re not trying to answer, you know, what’s the revenue by service or sorry, the margin by service.

Well, then you don’t need to ask for the service. And then, the only other thing I would add to it is once you have the template, then figure out how much resource you actually need to gather the data and put it into the report. Because if you don’t have that investment and so people time track, you got the template, but you got nobody on a weekly basis actually doing anything with the data. Well, then you just had everyone go through an exercise that they hate and that you’re not getting any value out of. So you got to think about the entire process, holistically.

Chip Griffin: Right. And I think you have to, I mean, in all the data that you’re collecting, you should always be asking that question, whether it’s for time-tracking or anything else, what question am I trying to answer?

Right. I mean, you should be thinking about that for your client projects, for your, your time tracking, for the financial reporting that you’re doing, understand what you’re trying to get out of it before you start setting the rules and choosing which packages to use and all that. And unfortunately, most people tend to start with the, oh, let’s start demoing a bunch of software for finances or time tracking.

Oh, I love this one. Let’s use that. Let’s use their template. Why? You, you need to think about what you’re trying to get from your business. I think the other advice that, that I typically give is make sure you’re trying to be accurate enough. You don’t have to be accurate down to the minute on most of your time tracking to get the information you need.

And so if an employee wants to use a timer on their stopwatch, on their computer to get it, great. But if you’re doing quarter hour increments, you’re probably going to get enough data that’s gonna be useful to you that you don’t need to worry about was it seven minutes or eight minutes?

Jon Morris: I completely agree.

Chip Griffin: So, you know, keep it simple, stupid.

So on the growth piece, because I do want to make sure we touch on that before we run out of time here. And it’ll be the last bit that we have a chance to cover today. You know, when you’re talking about investing in growth, I think you made a good point that if you’re not investing it, you can’t expect to be growing.

And I think part of the challenge is that agencies start out and they often have a growth spurt in the early years, because they are reaching out to a lot of the low hanging fruit in their network. And they’ve typically, you know, maybe they’ve picked up a client or two from, you know, what their last employer was or something like that.

And so they see this momentum without having to be really proactive at their sales and marketing efforts. But then at some point, typically, if you want to keep that momentum going, you do have to invest in both time and money. So, you know, how do you advise folks to think about the investments that they’re making in sales and marketing?

Do you have rules of thumb that you use? Are there, are there ways that you would like them to be thinking about how to track that return? So they know, yes, this makes sense, what I’m doing.

Jon Morris: Absolutely. So, the first thing is I teach everyone a language in terms of sales, and that language has to do with MQLs, SQLs, and opportunities.

So MQL stands for marketing qualified leads, and it means someone has raised their hand and said that they’re interested in working with you. You do not know if you want to work with them. You do not know if they meet any of your criteria. All you know is that they’re interested in your service. And SQL is you’ve talked to them, and you’ve done enough vetting to determine, you know, what I want to pursue this opportunity.

So MQL stands for marketing qualified lead, SQL stands for sales qualified lead. And then the third one is an opportunity and it has to meet a criteria called I call BANT, and BANT is an acronym that stands for budget, meaning that you’ve determined that they have the budget to actually pay for your service.

The next one is authority, that you’ve determined that they have the authority to make the decision. The third is that you’ve determined that they actually need your services. And the fourth one is timing, which is that they’re looking to make a decision in a timely manner. And if they meet those four criteria, you have an opportunity.

If they don’t meet that criteria, you might have an SQL. You still want to pursue it, but it’s not an opportunity. Now the reason why I bring that up is in order for you to grow, you have to generate new customers. In order to generate new customers, you have to generate opportunities. In order to generate opportunities you need SQLs or sales qualified leads and then marketing qualified leads. So what we want to start measuring is how many BANT opportunities do you get a month? And what is your win rate on those BANT opportunities? And so if you reach out to all your low hanging fruit and it just comes from your network, at some point you’re going to start seeing as a leading indicator, I don’t have any opportunities.

And so what you want to be thinking about is what are the investments I need to make and do those investments in sales and marketing lead to BANT opportunities? If the answer is no, well, then you have a pretty good at understanding that your marketing is not working. You know, I believe in investing in your brand, I believe in, you know, getting people to know you, but when you’re a small company, I believe much more in lead generation.

And do you generate BANT opportunities and are you winning those BANT opportunities?

Chip Griffin: Well, and I think the “are you winning” is important too, because I think there’s a lot of premature proposaling in the small agency community. Really agencies of all sizes but particularly small ones, they feel like they’re doing something.

And so they rush to, to send a proposal. So they may be sending proposals to folks way too early in the conversation. Before they’re even properly qualified simply because it feels like, okay, I’m making progress by putting them out there. Same reason a lot of agencies respond to RFPs that they have no chance of winning.

The problem is and as a financial guy, you can, you can help them understand this. They need to calculate the cost of preparing all of those proposals and pitches and roll it in. And that means that whatever few percent of those that they’re winning, they have to make up for all the money they’ve spent on all the losing ones just to break even.

Jon Morris: Couldn’t agree more. And if you go through that qualification process I told you about, and you don’t develop a proposal for anyone, unless they’re a BANT opportunity, you’ve just saved yourself a ton of money.

Chip Griffin: And you should have a pretty high win rate at that point.

Jon Morris: Exactly. I mean, just to give you an idea, you know, our win rate is historically around 70% in this business of our BANT opportunities we convert to customers. Now at Rise where it was a lower number, but there was a lot more competition. Right. And, so the, the next thing that you also want to think about is your number one sales goal is never lose a customer due to performance. You spent all this time and money to, again, to go win that business.

Well, especially if you’re in the retained agency world, as opposed to the project agency world, you know, the more you can hold on to that business going into the next year. You know, you have a large book of business that makes your life easier. This is one of my favorite stats. In 2019, 20% of our revenue was from clients we won in 2013. Think about that. A fifth of our revenue was due to something we won six years prior because we held on to their book of business. And so when you think about the investments you want to make, what you want to be thinking about first is are my services any good? Am I doing a good job? Are they truly differentiated? What investments do I need to make so that they’re better next year than they are this year?

Chip Griffin: And are they the right fit for those clients you’re selling it to right? It’s the whole, you know, you can sell ice to an Eskimo. Fantastic. They’re probably not going to keep buying it because they’re going to realize it’s sitting right outside their door already.

Jon Morris: Exactly.

Chip Griffin: So, well, we could go on for hours about some of these topics, so we, we will have to find other opportunities to engage on them, but, that unfortunately does bring us to an end of the time that we have available today. If somebody is interested more in learning more about you or accessing some of the resources that you provide, where can they find you?

Jon Morris: They can go to RamsayInnovations.com. That’s R A M S A Y innovations.com. They can connect with me on LinkedIn. They can also email me at Jon@Ramsayinnovations.com.

Chip Griffin: Excellent. Well, Jon, I really appreciate you taking the time to share a lot of this practical financial advice, and frankly, other management advice for agencies, you’re really bringing your experience to bear.

I know that listeners will have enjoyed it, and I appreciate everybody who has stuck with us listening all the way through. And I look forward to having you all back as listeners on a future episode.

Jon Morris: Thank you so much, Chip. It was great to be here.