Financial Keywords

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Financial

Keywords

By Jennifer Van Vleet

FEATURE

VOLUME 43 ISSUE 1

Financial acumen is crucial to your success as part of any business management or leadership team. As marketers, we supply constant rhetoric to the business about the need to know the client to best serve them well and it is no different for us. We must know our business to best serve it. A big piece of this is knowing how the operation works financially.

It is important to recognize that each business may talk about their operations differently. One company may frame success based on project gross margin and another may measure success in terms of net revenue earned. It is also common that companies may be talking about the same thing but refer to it slightly different. For example, company A refers to operating income and company B says operating Profit or just profit. The key is to learn the terms that are used by your company and then learn how to speak that language of finance. Moreover, you’ll want to learn what those words mean to the business.

Some Basics

Let’s start with a few basic foundational items that are important to understand. If a company is privately held (partnership, employee owned, individually held) vs. publicly held (traded on the stock market) this will drive many financial reporting exercises. Public companies are governed by the Sarbanes—Oxley act, commonly referred to as SOX. At its simplest definition it governs the implementation of consistent internal controls on financial reporting.

Publicly held companies sell stock (shares) to public shareholders so earnings (remaining money after expenses) per share issued is important. Think of stock as an investment. I give you an amount of money to use and in exchange for the money you give me stock or ownership in the company. Because I give you the money, this means I cannot spend the money, so I expect you to use the money to grow the business increasing the value of my stock. I also expect an earning sometimes referred to as a return or dividend. Selling stock is a key driver for the business. The business needs to sell shares to acquire capital (cash) so growth and providing a strong return to its shareholders are very important to attract continued investment.

Private companies may also issue shares to its shareholders (partners or employees).These shareholders expect the value of the stock to increase just like public shareholders. However, as the shareholders are most often employees of the company it allows a longer-term view of growth and return. Partners are often required to purchase shares of the company while employees are often provided shares as a part of a retirement or profit-sharing program. Therefore, private companies do not typically rely on selling shares to acquire capital (cash).

Finally, cash. It is more than a bill in your wallet. You’ve likely heard the phrase, cash is king. Cash is the lifeblood of a business. Cash is used to cover expenses which is a myriad of items including equipment, materials, payroll, insurance, and of course marketing. No cash means no profits and no investments, which equals no marketing budget, and ultimately no business.

In a billing rate contract a rate schedule is developed for each category of employee necessary to provide the contracted work to be performed. The rate schedule uses the typical salary value for each category of employee versus the actual employee’s salary. The cost multiplier is applied to the typical salary value. Since some employees will make more or less than the typical salary value the amount of profit varies by individual.

If the business has a lump sum agreement, the services are delivered for a set amount and the company earns the total fee regardless of hours worked, employee salary or expenses incurred. In a lump sum agreement, it is particularly critical to understand the complete scope of the services to be provided. Cost multipliers among other factors are used in determining the fee, but these cost multipliers are not shared within the contract. Lump sum contracts can be beneficial to a client in that they know the exact amount they will pay for the contracted services. Lump sum contracts can also be beneficial to the company if the company is able to complete the services for less hours or at lower rates than those used in determining the fee or the company required less expenses to complete the services.

Making Money

So, how does a business make money? The most straight-forward answer is by selling a product or service for a fee. To make a profit, a business must sell that product or service for more than what it costs the business to provide that product or service. To do this a company must think about several items and two that are common in our industry are contract terms and fee.

The contract establishes an agreement between parties as to what and how the work will be performed. Also, within the contract, the fee is established. The fee is the amount of money that is charged for a product or service. In our industry, there are a few different forms of fee structure you will encounter. Most common are lump sum, billing rate, and cost multiplier.

We talk about rates as the amount of money that can be charged for an hour of an individual’s time. All the people collectively working on a project at certain rates plus expenses add up to what is called the fee, or the total amount the business will charge someone for its services. When a client agrees to a fee, then it is agreed to how much revenue will be received.

A business can make a profit on rates based on the cost multiplier. An employee costs a certain amount for a business to employ (salary, benefits, technology, etc.). The cost multiplier is a factor that is applied to an employee’s salary. So, if your firm talks about needing an average cost multiplier of 3.0 for individuals, it is needing to earn three times the cost of the person’s salary in order to cover the total cost to employ, overhead costs and make a profit. So, if a person’s salary is $30, their rate at a 3.0 multiplier is going to be $90. You can also have a cost multiplier on expenses. It is common to have a multiplier on subconsultants and subcontractors usually no more than 10 percent.

Lump sum contracts can be beneficial to a client in that they know the exact amount they will pay for the contracted services.

The difference between the amount of money paid (fee) and the costs to perform the work is called project gross margin. This is the money left over after the company’s costs to perform the services are deducted from the fee (revenue).

The idea of a cost multiplier and the ability to charge a client for someone’s time drives the definitions of direct (billable) and indirect (non-billable) employees. The people a business includes in the work on a project are direct and those that the company cannot include on the project are indirect. Marketing staff are often indirect staff unless the company can include them in a role in the project directly.

If marketing and other functions are not billed out directly, it is necessary that those who can be billed out are being billed out at a cost multiplier or billing rate high enough to cover these costs. Also, it is necessary to make sure a high enough volume of hours is billed out relative to those hours which cannot be billed. This is where the concept of a utilization rate (chargeability etc.) comes into play. Companies calculate all their overhead costs (items and people that cannot earn money for the business directly) and then figure out how much time needs to be spent by the those who can earn money directly for the business to cover these costs and earn profit. Profit is necessary to reinvest in the business, pay bonus, and dividends to shareholders. Businesses must then balance the need to meet a utilization target to cover costs with the amount of people needed to meet this number. If the business is short the number of needed people, it will risk burning out the direct employees available that have to bill all the hours.

Money is Made

Employees are billing hours, contracts are in place, and money is coming in the door. How do companies measure and discuss their financials? Revenue is commonly referred to in terms of gross and net. Gross is the told amount of fee agreed to in a contract before any costs to earn that fee are subtracted out. Net revenue is gross revenue minus the total amount of expenses (subcontractors, travel, technology, paper, mailings, etc.) required to perform the agreed work in the contract. From the net revenue you subtract the salary costs, and the remaining amount is the project gross margin.

However, project gross margin does not equal profit. Project gross margin only considers the costs tied directly to the revenue. This is often why marketing is so keen to tie their costs to capturing revenue (proposal hours and materials). All the time not spent on efforts directly tied to a proposal are considered other costs that must be covered someplace else. This is also why marketing and proposal teams want to show strong win rates (number of jobs won) and capture rates (the dollar value of the wins) for pursuits.

Understanding revenue is important to a business. You will hear companies discuss their forecasts (predictions of monies to come) and often in terms of factored (or weighted) net revenue. A company will take all the potential opportunities it has and look at the probability of the both the project proceeding and then the chances of winning that job. Factored net revenue is equal to the net revenue times the probability of proceeding times the probability of award in percentage terms. Just because an opportunity may come to be a project, a company must account that some will not or that they will not be successful in winning the opportunity. To then make decisions on budgets and monies to spend now based on current monies and probable dollars it cannot account for the revenue at full value. Backlog is the net revenue that can be accounted for more reliably as this refers to the jobs that have been awarded to the company and are either scheduled to start or are currently active.

Companies have to forecast in order to manage spending. This includes all overhead spending, including the marketing budget and associated investments. A well-run business will not commit to spending money if it doesn’t believe the costs cannot be covered now or at some future point. A company doesn’t last long if it is running at a budget deficit (spending cash it doesn’t have). Remember cash is king.

A well-run business will not commit to spending money if it doesn’t believe the costs cannot be covered now or at some future point.

It is important to remember the revenue does not include the cost of sales. The cost of sales includes certain of the marketing and business development costs associated with pre-positioning and the proposal preparation itself. These monies are typically not reimbursable by the client and are part of the overhead cost of the company. Finally, the cost of sales is typically incurred at the time of the expenditure. Revenue is recognized as the work is completed.

Again, revenue is not profit. All costs to complete the work and all overhead costs to operate and support the business must be subtracted from the revenue before you can arrive at the profit.

This is Complex

Finance is its own profession and the words and concepts mentioned here just scratch the surface. However, this is why accountants and other finance professionals, who like marketing are a cost or indirect employee, are employed by our firms. You don’t need to understand everything the CFO or treasurer of your company knows, but you do want to be able to speak some of the same language, understand how the business earns money, and know what are the considerations that come into play when choices are being made to make investment decisions.

Get to know your accountants and finance team. Ask them to walk you through a project and the costs associated with running the business. You can share with them about how items that marketing needs to invest in and the efforts you do tie back to profits, revenue generation, and efficient utilization rates. Speaking the same language will make for a much easier working relationship.

Sources and further reading

Jennifer Van Vleet, CPSM, vice president, marketing and communications, global at Stantec in Denver, CO. She oversees a global team of marketers spanning five continents and multiple languages.

Email Jennifer at Jennifer.vanvleet @stantec.com

Contents

Some Basics

Making Money

Money is Made

This is Complex