Measuring and understanding sales and profit growth
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Sales and profit growth: How to measure and understand sales, profits, costs and cash to drive your growth and attract buyers. Strong, predictable growth in Revenue, Gross Margin and EBITDA, underpinned by good day rates and utilisation, are highly sought after by buyers of consulting firms. Find out how EBITDA value and growth rate drives up the profit multiple, business value and attractiveness.
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Measuring and understanding sales and profit growth
- 1. Confidential© Equiteq 2015 equiteq.com Growing equity, realizing value 8 Levers Webinar Series Sales & Profit Growth Webinar
- 2. Confidential© Equiteq 2015 equiteq.com Sales & Profit Growth
- 3. Confidential© Equiteq 2015 equiteq.com 3 8 Levers of Equity Growth for consulting firms Market Proposition Intellectual Property Quality of Fee Income Sales & Marketing Process Consultant Loyalty Client Relationships Sales & Profit Growth Management Quality Equity Growth Wheel
- 4. Confidential© Equiteq 2015 equiteq.com 4 Sales & Profit Lever Market Proposition Intellectual Property Quality of Fee Income Sales & Marketing Process Consultant Loyalty Client Relationships Sales & Profit Growth Management Quality Equity Growth Wheel
- 5. Confidential© Equiteq 2015 equiteq.com Consistent, strong, profitable (EBITDA) growth Day rates, Utilisation and Gross Margin Organisation structure and leverage model Contractors’ margins & usage The importance to Buyers: Strong predictable growth in Revenue, Gross Margin and EBITDA underpinned by well balanced structure with good day rates and utilisation are compelling and highly sought after. EBITDA value and growth rate drives up the profit multiple, business value and attractiveness Key Messages • Drive GM to > 50% • Drive EBIT to > 20% • Aim for > 20% pa organic growth • Manage cash so that growth isn’t constrained • Ensure predictability 5 Growing or maintaining profit is crucial to both survival and revenue growth Market Proposition Intellectual Property Quality of Fee Income Sales & Marketing Process Consultant Loyalty Client Relationships Sales & Profit Growth Management Quality Equity Growth Wheel Sales & Profit Growth lever is about:
- 6. Confidential© Equiteq 2015 equiteq.com What is the best practice revenue and cost mix to deliver maximum shareholder value? 6 • 50% Direct Delivery Cost – the cost of staff and the basis of project profitability • 30% Overhead – the cost of marketing and selling, managing and sustaining the business • 20% Earnings before Interest, Tax, Depreciation & Amortisation (EBITDA) RevenueOverhead EBITDADelivery Cost 50 30 20 100 0 10 20 30 40 50 60 70 80 90 100
- 7. Confidential© Equiteq 2015 equiteq.com Overhead should typically represent 30% of spend across 3 main areas 7 • There are many opportunities to under or over spend in each area • The target is to achieve 50% Gross Margin • Is the balance right in your firm? 35 15 20 10 10 10 0 10 20 30 40 50 60 70 80 90 100 Sustaining the Business Managing Business Generating Business Project Mgt & QA Direct Delivery Cost EBITDA
- 8. Confidential© Equiteq 2015 equiteq.com Please make use of our free thought leadership material 8
- 9. Confidential© Equiteq 2015 equiteq.com Growing equity, realizing value UK +44 (0)203 651 0600 USA +1 (212) 256 1120 Singapore +65 6352 7482 Email info@equiteq.com www.equiteq.com
Editor's Notes
- Paula - Hello & welcome to the 2nd of webinars in a series covering each of the 8 levers in Equiteq’s Equity growth wheel. Today’s webinar is on the topic of Sales & profit Growth. I’m Paula, Marketing Director at Equiteq based in our London Office and our presenter for today is Shant Yeremian, our Buy-Side Director from our New York office. Shant will be taking a look at best practice sales and profit growth which will take about 20 minutes, then in the last 10 I’ll be putting your questions to him. Please post your questions using the control panel on the right hand side of the screen. The questions box appears towards the bottom.
- Hello everyone. I’m Shant Yeremian and I head up our Buyer Coverage Group and its through this lens that Ill be speaking about the topics today. So today’s topic is about the sales & profit growth in a consulting firm. If you can only remember one thing, please remember this – In the consulting market, buyers only acquire growing firms. A good 2 to 3 years of Revenue and Profit growth is what most buyers want to see, and one bad year can reset the clock in terms of the optimal time to sell. Your firm’s sales and profits are a reflection of a number of factors, including: What you’re selling / What are your offerings, and How well do they address the demands in your core market? How well are you able to delivery your services to your clients, and manage / maintain clients for sell on / repeat business, while focusing on growing new business. How well can you manage the operations of your firm and how well your firm is able to scale with increased demand for your services All of this is reflected in your sales & profit growth in a very measurable way. IF you’re doing well, your firm’s finances should be doing well. Investments made in one year should pay off in increased sales or profits in another. That’s what this lever is all about. How well are you able to manage your business in a way that results in a pattern of growth that you can confidently project going forward. It is important to have a great market offering and talented people with expertise to deliver the offering, but if you are not able to translate this into growth of your revenues and profits, then you are not adding equity to your firm either. Stagnant or fluctuating financials do not grow equity and can erode equity the longer you remain stagnant. The implication is that you need to manage your sales and profits in a way that makes your firm an investable business through the eyes of an external party (i.e. an acquirer). As I said, Buyers in consulting only buy firms that are growing, because there are no underlying hard assets to ‘sweat’ or sell off – your income is all due to your human capital. While you may not be focused on the sale of your business, the question about value is indicated (not necessarily determined by) how much someone is willing to pay for your firm. So again the one thing to remember is that its is the growth of your revenues and profits that adds equity value to your firm, not simply the fact that you have revenues and a profit margin
- So taking a step back from the Sales & Profit lever, I want to put that message in context. The picture here shows the Equiteq ‘8 Levers of equity value’. It’s one of our proprietary benchmarking tools that has been used in our M&A advisory work with almost 400 firms. The categories or equity levers shown here reflect the key factors on which a buyer will evaluate your firm. The principles of equity growth and valuation in professional services firms are not always well understood by owners. Or by most M&A advisors for that matter. As owners, understanding these levers of equity growth is the most important route to building sales & profit and equity value. This is the way to unlock significant personal wealth at a liquidity event, like the sale of your business. A buyer interested in acquiring your firm will comb through your operations to establish the level of risk associated with buying you. He’ll want to know if he’s going to get a good enough return on his investment. Our benchmarking tool, which sits behind these 8 categories, asks all the operational questions a buyer would be interested in and, identifies those risks a buyer would find if he were to do exactly that. The tool allows us to analyse the answers and produce a prioritised set of actions that you can take to mitigate those risks and enhance the value of your firm.
- . So with that overview of the Equity Growth wheel, lets focus in again on the Sales & Profit Growth lever
- Id like to start with a simple message we hear from buyers all the time and that is reflected in an independent buyer survey we commission every year. It is this: “Buyers of consulting firms want, first and foremost, their acquisition targets to have financial stability”. Why is that important? Well from a buyer’s perspective, if a firm can not profitably grow on its own, why should it be a good investment? So Sales & Profit growth is important, very simply to show that what you have is in demand, that you can make money from it and that you can scale your business to meet growing demand. In this respect, sales or revenue growth is actually more important to buyers than profit. For instance, if it comes to choosing between continued revenue growth with stagnant profits, or stagnant revenue with growing profits, the former will be more acceptable to a buyer. It is also critical to show consistency between past and future performance, so the shape of your growth curve is important. Jumping up and down in Revenue causes questions by buyers about the real underlying value of your services and may deter buyers. The key is to present your financials in a way that reflects the growth of your underlying business and that ideally shows fluctuations to be temporary or not part of the fundamental growth curve. So what are the drivers of Sales & Profit growth in a consulting firm? Revenue = Price x Volume Price is about charging market rates for the type and quality of services you offer. In consulting we talk about day or hourly rates charged to a client, and it is important to get this right. While price may change with inflation or the type of service you deliver, it is not likely to be the big driver of revenue growth. The right day rate should reflect what the market will pay for your services, and any changes to the market rates or your level of value added to your services should be reflected (increase/decrease) in your rates (high demand services can be charged at a premium, lower demand services should have a lower day rate in order to capture sufficient volume, etc.) Your Volume of work is the obvious way to increase revenue. This is about increasing the number or size of engagements and this is the key to revenue growth. The more you sell, the more revenue you generate, but selling more requires increasing demand, which we will deal with in our Sales & Marketing Process lever, in another webinar. Profits Now any discussion on profit has to consider cost management. And that is in fact our big focus on Profit growth. This is about managing to a best practice cost structure for a consulting business model that allows you to scale and leverage your business as you grow in demand and ultimately revenue. A critical element of this is Utilisation and ensuring your employees (your main assets) are maximizing the amount of revenue they generate for the firm. Without this focus on utilization, its like paying maintenance on a car that sits in your garage more than you drive it. With this focus on Sales & Profit Growth, some benchmarks can be highlighted that I’ll elaborate on shortly. These involve driving towards a 50% gross margin, a 20% EBITDA margin, a healthy but manageable level of growth, and some common factors like managing cash and ensuring predictability of the growth.
- So let’s decompose some best practice financial metrics in consulting to see why those proportions are important. Looking at a breakdown of revenues, it question is how you spend what you are earning. Of course all we need to retain a level of profit and costs involve both costs that deliver work and those needed to run the business. So Delivery costs and Overhead costs. What remains is EBITDA, a normalized measure of profit. So how to we come to these proportions? Well lets take the starting point of what buyers want to see. Most buyers are comfortable with a 20% EBITDA margin when looking at acquisition targets. If the target firm is achieving a 20% EBITDA margin, then it says they’re doing something right and have a healthy level of profit for a consulting business, so the focus moves to what the firm actually delivers and its capabilities. If the target firm achieves less than 20%, it can cause questions in the mind of the buyer, particularly for smaller consulting firms. The tolerance varies with each buyer, but taking 20% as a good EBITDA margin to achieve in order to attract a buyer is a good starting point. Why 20%? If you think that the global average multiple for all consulting firms is about 1x revenue, a 20% EBITDA margin means a 5x EBITDA multiple, which falls within an acceptable valuation. This leaves 80% of the revenue up for grabs. Another important metric is to achieve a 50% Gross Margin. This provides a balance between keeping your staff pay at market rates and having enough left over to pay the costs of running the business. A good rule of thumb is that your offering should be charged at 3x what you pay your staff for the amount of work. Then adjusting this ratio for about a 70-75% assumed utilization rate of your staff gets us to a 50% gross margin. So 50% Gross Margin is what a consulting firm should aim for.
- A further breakdown shows these proportions in more detail. To achieve a 50% gross margin, its necessary to spend an appropriate amount of time and cost on both delivering and project managing your work. So a 70/30 split (or 35% and 15% of the overall revenue respectively) works well. The majority of costs are spent on delivery and execution, while a good proportion is used to manage and assure the quality of the work. So with 20% retained EBITDA and 50% allotted to deliver your work, the remaining 30% is for Overheads. We find that an even division of overheads across Generating, Managing and Sustaining the business is best practice. Generating business refers to Marketing, Sales, and Business Development; Managing the business refers to paying the leadership and top management of the business (MP or CEO, CFO); and Sustaining the business refers to the remaining functional needs, including Finance, IT, HR, etc. Aiming for these proportions is not always easy, and some need to be traded off for others during periods of change. However, these benchmarks are a useful guide and metrics with which to manage your consulting firm, in order to ensure ongoing sales and profits are managed in line with buyer or investor demands.