The Virtual CPA Success Show for Creative Agencies: Episode 19

In this episode, Jamie Nau and Jody Grunden talk about how to measure and improve your average bill rate: The average bill rate is your total revenue divided by your number of billable hours.

Average bill rate is a key metric for creative agencies because it’s how you know how much money you are collecting for the hours you are working.

Jamie Nau: Hello, everybody. Welcome to today's podcast. Today, you have Jamie and Jody here from Summit CPA, and we're going to do a deeper dive on a topic that we've briefly touched on in the past. We're going to continue to do this as we roll forward on these podcasts. We've talked about this at a high level on some topics, but the more you know about a topic, the better it is to act on it. So today we're going to work on average bill rate, and kind of talk through on what that means, and ways to improve it, and how to how to gauge whether you have a strong average bill rate or a weak average bill. So Jody do you want to start off with the real basic calculation. I know we've covered this before, but just kind of give the basics of an average bill.

Jody Grunden: So a lot of times when we talk at conferences we ask for everybody's average bill rate, and we get a lot of different numbers. The most common number that they give us is not a dollar amount, but what they call average bill rate that they're referring is a lot of times what they're actually billing a client, which is we call our standard bill rate. And so a standard bill rate is, you know, if I'm going to bill a client $200 per hour. That's the standard bill rate. If I've got many different standard bill rates, let's say my architect is $200 now, or my dev is $175, my design is $250, whatever that might be, that would be considered a blended standard bill rate. What we're talking about today is not really what you're charging a client, but what you're actually realizing from that sale. So an average bill rate is technically, the definition is, taking your total revenue and dividing it by the number of billable hours. So it's a very simple calculation. Everybody can do it if you've got a good time and billing software that you can just look at your total billable hours for a period. You can do that for the whole company to get your average bill rate for the company. You can do that by different projects to get the average bill rate for a project. So it's really a simple calculation. But we have to make sure that when we are talking in this episode that we're actually talking apples and apples, average bill rate versus a standard bill rate, or a blended standard bill rate.

Jamie Nau: Yeah, I think the important thing to note here too is standard bill rate does matter for when it comes to your average bill rate. Part of this conversation will be how to increase that standard bill rate because it does help your average bill rate. But if you're going out there trying to charge $300 an hour and then not charging half your hours, then obviously your average bill rate is going to be deeply reduced from there. So it is important that we are focusing on that average bill rate because it is important. That's ultimately what you're collecting. Doesn't matter what you charge or what you say you're going to charge, what matters is what you actually collect. So that's why we're going to focus on that average bill rate.

Jody Grunden: Yeah, for sure. I had a client send me a Slack message the other day, and she was asking, what is our average bill rate, or what should our average bill rate be? That was a major initiative for them. It really comes down to how much are you charging? You know, what do you feel that you can charge a client? So that's going to be on the sale side of it. Then the other part of it is going to be what is your effective cost? How much do you actually pay your employees? You know, because if you're outsourcing your entire team, maybe to a country that has a lower cost, than in that case your average bill rate doesn't need to be where everybody else is at. It could be a lot lower because your profit margin is going to be relatively the same if you reduce it based on that gap between the effective cost and your average bill rate. So it's important that you understand your company before you just come out and ask hey, what should my average bill rate be? Because there's a lot that goes into it outside of just looking at what everyone else is charging. That's not the way that I would do it at least. You might find you have a competitive edge if you charge less and make more, or if you charge more because you've got higher quality staff, more expensive staff I guess is probably a better term. You may have to charge more. You may not have that option of charging less. So it's important to understand what that average bill rate is, and more importantly to understand really what your effective cost is so that you can determine that average bill rate.

Jamie Nau: Yeah, and something I've worked with clients on as well is having a sliding scale here. A lot of factors can play into making one average bill rate better than the other. If you're going to have a one month contract and that one month is all that's guaranteed, then maybe you want to go with the higher average bill rate, or if that client is just a one month client but it’s in your industry, it's someone you could impress and turn into a long lasting three year contract, maybe you're willing to go a little lower. On the other side, if you're in the initial contract negotiations and someone is looking for a one year deal, you might be willing to accept a little less because you get that guaranteed revenue for the next 12 months and it’s something you are going to be able to forecast and can predict in having that lower rate there. So a lot of times I've worked with clients on first establishing that ideal average bill rate and then kind of go in scales of what could tip the scale one way or the other? And just having little calculations in there while they're doing their negotiating to be like A, this client's going to pay us fast. They promised ten day terms. B, it's going to last a year let's go to the next level. C, we're not going to charge our normal level, we're going to charge them $180 because we have all these positive factors in there. That's a thing that I've worked on with clients to easily do on their own if you understand that base average bill rate.

Jody Grunden: I'd also say if you are in a situation where maybe you've got a cliff, you know, where maybe a project's falling off and you've got maybe 15 days before the next project starts, it's not a bad idea in taking a very small average bill rate just to fill that time. That's a lot better than no bill rate at all. That might be one of those pet projects. Let's say maybe the church down the street needs some help on a project. Obviously your bill rate is way higher than they can afford, but you've got this little area if they're willing to work within that gap, you know, you could use that 15 days and do their project at a much lower rate. Again, much better in getting something than nothing, right? That's the idea there. So don't fool yourself and think, hey, we can't lower price because it's going to lower the average bill rate. You know, again, zero is a lot worse than getting maybe one hundred dollars when your average bill rate is normally two hundred.

Jamie Nau: In going back to Jody’s point earlier, understanding what that break even average bill rate is super important. Knowing what your costs are, and really understanding your income statement so you can kind of back into it and say okay yeah, one eighty gets us to that fifty percent gross profit, which is great. But if we need to fill some time, or we're in a really bad time where in the last three months we just had no projects come through with. Obviously right now a couple of our clients are working with that now because of the current economy. So you could say, I'd rather have my team here and working on something than not doing anything. So understanding that break even rate is super important as well. It also gives you that scale time. Like what I was talking about with the two hundred, if you know the lowest you can go is one ten, then now you know that you can’t work lower than that.

Jody Grunden: To Jaimie's point it's important to know that, but in the same regard, I'll take a loss for 15 days if I have money coming in the door. I mean, I'd have no problem with that. Just as long as it’s not a long term deal. If it's a long term deal, absolutely not. So you have to know what that break even is, and you've got to know what your bill rate is and you've to command your bill rate. You can't take a loss or a really small, small margin on a long term contract. That will more than likely lead to disaster.

Jamie Nau: One last thing I have on what you charge clients part of this calculation is, I have a couple of clients that have multiple different industries, or multiple different sectors, and they make sure that they get a lot on the big companies that they're working with. So like a Facebook or Google, Ford, some of these large companies. Those companies would be willing to pay more. So you can you can charge them a little more. There’s nothing wrong with that. There's nothing unethical about that. That's just the type of work you're doing is more valuable and it's more valuable to them, and they're going to pay a little more. Then you can blend that with some startups. So if your industry is doing large companies, but also startups, you're not going to charge your startup the same that you would those large companies. Just to understand those two things and really have that part of the scale as well just to know. A startup is never going to pay the same rate as a Facebook. So that's not going to happen just because of where they're at. So anything else on kind of finding that standard bill rate, and pricing for clients that you want to talk about before we get into write downs and once a job has started?

Jody Grunden: No I think it's just important that the communication between the sales and the project manager, the account manager, it's got to be completely a transparent transaction, because what happens is, and we're going to talk about write ups here in a second, it's important that it's really on the very front of the engagement. So we recommend always having, the project manager, whoever is leading that project in on the sales discussion or signing off on it before it's actually brought down to them, because that's going to really potentially lead to some major write offs, write downs, if there's something missing, the scope changing a little bit, you know, miscommunication, that sort of thing. So we did we definitely want to make sure that on the front end, looking for your price, make sure that the sales and project manager is involved in that discussion.

Jamie Nau: Yeah that's a great lead in because that is what we are going to talk about next, the write down, write up. I think you're 100 percent right. I think the first step to that is having the PMs, and having people who understand the project involved in the sales process. That's the number one tip that I give people. I can’t tell you how many times I've been in a revenue rec meeting and we're talking about percent complete, and I hear the PM complaining about the salesperson. Like I don't know why they sold at this rate, there's no way I'm ever going to do it. And my first comment is why weren’t you involved in the process? How can we build our controls better so we don't get those type of jobs? And again, sometimes they're okay. We talked about that if it’s that client you've been trying to work with for six months now, sometimes you're willing to take a little bit of a write down on it. But ultimately that to me, the first step is just understanding what goes into that pricing model. That is key. So Jody you want to talk a little bit more about what leads to those write ups and write downs? What exactly we're talking about there. Just to make sure our audience understands that part of the calculation?

Jody Grunden: Yeah, for sure. So when we say write off, we're not talking about a bad debt situation. We're not talking about after the projects over the company fails to pay you. We're not talking about that. What we are talking about is what was expected to be billed out. What actually does get billed out. The difference between your standard rate and your average bill rate. So when you do your calculation, you know, if everybody does that, look at your total revenue divided by total billable hours, and let's say it comes out to exactly the 200 dollars an hour, and that's what you billing your clients, high five. You're getting exactly what you're billing. I would guess that if everybody does that, that's not going to be the case and you're going to probably find big swings in there. What we like to say is that big swings really should not be more than 5 to 10 percent. If it's over 10 percent, there's some major, major issues that you've got to correct. And don't look at it as being a one off all the time because everything becomes one offs. Do a deep dive and figure out where did we go wrong? Where are we going wrong, where can we fix the issue? Because there is definitely an issue. If it’s between a 0 to 5 percent, probably not a huge issue at all. You know, probably something you can live with. I wouldn't worry about it too much or lose any sleep over it. I'm really not going to lose a sleep when it gets up close to 10 percent. But I will start losing it when it gets, you know, greater than 10 percent. And so there's a lot of reasons for why you might not be getting that complete thing. You know, we just talked about the sales, to the miscommunication, you know, the communication gap between sales or biz dev and project management, that's one. That's a big one. The other one is basically just managing the project. The project maybe going over scope. And instead of billing forward or getting approval before we add extra stuff, we go ahead and do it and then find out afterwards we can’t actually bill for it. Or we decide not to bill for it and we're all guilty of that. We always want to provide a service that's cooler, and basically show that we can actually do it. So we want to provide that, but we have got to make sure that if we're providing something better than what we're scoping, we've got to make sure that we are actually getting approval before we do it, because a lot of times it leads down to a rabbit hole that is going to cost you in the end. That’s when you have a big write up, or big write down in that case.

Jamie Nau: Yeah I think to that point, the key there is this communication with the client as you're going through it. The whole team needs to be in sync from the lowest level to the highest level, they need to understand what the original scope was. So if the lower level designer starts working on something that's out of that scope, we need to make sure the client's aware of it and say, hey, just so you know, I'm going to start working on X, Y, Z, this is out of the scope. Every hour I spend on this we're going to have to negotiate, or this is the rate it is going to cost you, be a bit more straightforward with it, or say let's talk about it before we start the work. It's a lot easier to have that conversation then, than it is when the projects going on for 90 days and it's over. Now you're trying to send that final invoice and say oh by the way, in month one we spent 100 hours working on just part of the thing that you requested that was out of the scope, pay us for it. Most clients will laugh at you like, no, we had no clue what was going on. So the big thing about scope changes and scope creep is the communication throughout the process. The big thing there is making sure everybody understands what the scope is, and understanding who's the one to have those conversations and to have it quickly and timely. That's the biggest thing that I think that I've seen be effective with trying to reduce those type of write downs.

Jody Grunden: For sure, and the transparency that we give our project managers is going to really help out in determining that average bill rate, making sure we maintain that average bill rate. Oftentimes our project management team really has no idea what our effective cost is. If you don't know that then it's really hard to determine if you're on the right path or not. They're just looking at hours. But as we all know, everybody's hours differ. You know, my hours are going to cost more than somebody right out of college is. So transparency is really important. Now, there is a way getting around that without actually opening up the playbook when it comes to how much we're paying everybody on the team, you know, because you may not want the project manager knowing that, you can use that average bill rate. So Jamie, if you can explain how you would walk a client through utilizing that average bill rate to determine job profitability, I think that would be pretty valuable for the audience.

Jamie Nau: Yeah, for sure. So it goes back to what Jody mentioned before. You understand your costs, you understand how much you're paying your employees, and you understand what it takes for a job to be profitable within your organization, than the average bill rate is all you really need to know. So if I know I'm paying my employees on average, fifty dollars an hour, obviously I need to take into consideration there some utilization, but let's just say that fifty dollars an hour equates to one hundred twenty five dollars average bill rate, that's the starting point. And again if you use that as your starting point and you say, I know I need one hundred twenty five dollars an hour, but I priced this one at one hundred fifty. You understand that you priced that one at one hundred fifty and you're going to get a little bit higher than that 50 percent gross profit, that's all that your PM needs to know. How they are doing on average bill rate throughout the project. And for them to do that it is super simple. They just need to know how much revenue they've earned and how many hours they've worked. So at any point in time they should be able to calculate it. So on a certain project, I worked this many hours and I can take it out of my time software and calculate how much revenue I've earned. Right there in the software is also how much billable hours you have. You can see what your average bill rate is at any point in time. Then I think the second part of that, which I always recommend is don't just do the average bill rate now. So as of day 10 of the project, our average bill rate is fine, but also do it at the end of the project. So all of your PMs should be able to lay out a planning document, whether it's in the Harvest Forecast 10000 feet, or just on a spreadsheet, they should know that this is what it's going to take for me to complete this project. By the end of this project this is where I would be at. That’s really important when you're talking about those fixed price projects because at any point in time you're going to feel like you're doing okay unless you throw in those to completion hours. Then you really know okay, at the end of this project, if we keep going at this pace, we are only going to get ninety nine dollars an hour on this project. That's not good. We need to either talk to the client today. We need to change something. We need to change the team on here and be more efficient, or do something to get that rate back up, because if not, we're going to have a pretty significant write down.

Jody Grunden: For sure. So can you kind of walk through how we do our revenue rec when it comes to a flat fee project? It's fairly simple at a time and material. Hours billed equals hours worked, that that type of thing. But how do we do a fixed fee project? And let's say that we had you know, you could throw a number out there, but you're tracking hours as you go. How is the revenue determined I guess?

Jamie Nau: There's a couple of ways to do it. Again we have talked about this in presentations before. So if you ever have a chance to see us talk we'll go into this in little more detail, but it really just depends. You want to try to tie that revenue to when it's earned as best possible. So one of the easiest ways to do that is if you have milestones. And so every time the milestones achieved, you know that you've earned some part of revenue. Again milestones aren't always equal. But let's just assume it's a one hundred fifty thousand dollar project and there's three milestones. You can take fifty thousand dollars once that milestone is achieved. And again, if you're halfway through a milestone, you can kind of estimate it there. But, you know, milestones is one way to do that. It's pretty, pretty simple, pretty basic, but it gets you close. And so that that's one way to do it.

Jody Grunden: Milestones aren't tied to hours, right? They are just simply when projects complete certain levels.

Jamie Nau: Yes. So if you know stage one is the discovery, once you get done with the discovery you are 10 percent done with the project then you can recognize 10 percent of the revenue. Then stage two is once you get stage one done, you presented it to the client, that’s stage two. Stage three is going back and doing the cleanups, and that's another 50 percent, or however you want to break it down. If you understand the stages of the project and know that they mean we are X percent is done, then you can use that to recognize the revenue as opposed to the hours. That's one way to do it. It’s the simplest way. The other way to do it, and this is kind of what I was alluding to earlier, is if you as a PM understand what percent complete you are, then you know how far your revenue is. So if I have a schedule and I know a project's two hundred thousand dollars is the total project, and I can see how many hours I've done. I also have a document of how many hours it's going to take me to complete. I know how far along I am on this project. Originally if I thought it was going to be a two thousand hour project and I've put in fifteen hundred hours and I'm only 50 percent complete, obviously I'm behind. A thousand hours would be that 50 percent complete that I think I'm at. So you'd have to put that thousand dollars on there and say okay, I can really only recognized 50 percent of this project or two thirds of this project, which means I'm behind. So it's basically just understanding the project as a whole, and knowing what percent you are complete and just using that to do the revenue. So actually, it's not that complicated if you're just looking at a project in total. It’s how much time do I have left? How much time have I put in? And what percentage am I at? So then you could just know okay. I am 60 percent of the way done, 60 percent of a two hundred thousand dollar project is one hundred twenty thousand dollars. That's how much revenue I'm going to recognize. And then divide that by your billable hours and you can see exactly where your average bill rate is at.

Jody Grunden: I think it's pretty clear. The one thing there is you can have a twist to that. What our team will do is on the percentage complete what they're going to actually go with actual hours up until 70% of the project's complete and then start actually breaking it out as a percentage, because a lot of times we underestimate or overestimate in that first part. And it's really tough because you're in the first part of a million dollar engagement, or first part of a three hundred thousand engagement. It's really tough to determine if I’m 25%? Am I 30%? So a lot of times we'll just go strictly by hours. Then once they get to that 70% or 65%, then we actually break it down as a percentage a complete. So you can do both. If you’re really good at at estimating that first part, or we get some sort of milestone or some sort of indication that 25% of its done, then we'll go that route. And if we don't, we'll just use strict hours like Jamie was saying. We will go strict hours all the way through and then start breaking it down, and start having our write offs typically towards that last quarter. And that's probably the most conservative method of doing it, in my opinion.

Jamie Nau: I think the key there too is just knowing the sooner you know that you're going to have a write off the easier it is to go to the client and talk about it. So again, you don't necessarily need to know in terms of dollar amounts how much the write offs going to be. But if you know in that first third of the project it's going out of control and they're asking for a ton of scope changes. and you just know this project's going backwards, you need to talk to them instead of waiting until the fourth quarter. You don't necessarily need to know how much revenue you have, or your average bill rate, but you need to know if you're falling behind.

Jody Grunden: One hundred percent agree. I'm referring more to the revenue rec than I am to job profitability in that regard. And if you're ever under an audit, and I am talking about like a financial statement audit where you've got to do your audit once a year, being more conservative and doing it 70% is going to be more favorable to the auditor than if you're recognizing a lot of your revenue upfront, which could be a bad thing. So make sure that you know the situation and understand what who your audience is. If you're not an auditor, if you never been under an audit and you just worry about the IRS, well the IRS is going to want the revenue be recognized a little differently. So make sure that you're really consistent, and you're recognizing revenue to your audience for the most part. And try to stay in what we call a gap accounting, if you can. I know a lot of people will have the accounting acumen to actually stay exactly within that. So like I say, try to stay as close as you can to when the revenues earn and you should be okay.

Jamie Nau: Okay I'm going to take a quick second here to throw our email address out. So the emails have started to pick up, which is nice. I know we have listeners out there with questions for us, but I want to throw it out there so people know it. Again, we want to make this show for the listeners. So if there's any topic you want to talk about, any questions you have specifically, or even if you want to be a guest, we'd love to have you on the air and kind of talk through your issues individually. So that email address is: vcfo@summitcpa.net. So last topic here, Jody, is for you. We talked a lot about write offs. So what about write ups? So if I have a 20% write up is that a great thing? Do I need to change anything about my business? Is there any level where I should start worrying about write ups?

Jody Grunden: Oh definitely, or sure. I think write ups are probably equally as bad as write downs. That's going to come as kind of a weird statement to say because you're actually making more than what you would have charged. What that's telling me is you're probably not charging enough, and there's probably a lot you're leaving out there that you could have actually charge even more on. So if it's a onetime deal, that's cool. No big deal. No change there. But if it's a constant thing where you're constantly writing up, then you probably want to start quoting a little bit more. Quoting a little bit more, getting bigger deals, I think that's a big sign for that.

Jamie Nau: Yep I agree. The part it gets tricky with is your capacity planning. If you think a projects going to take three thousand hours over the next three months, it only takes two thousand, then obviously you're having people sit on the bench more than you should, and you could be making additional revenue. That’s the other part of it, too. Both write ups and write downs mess with your capacity planning, but write down specifically means you're still leaving revenue on the table in terms of people's hours not being used.

Jody Grunden: To Jamie's point, it would be kind of interesting if you did it and you find out, oh we're having write ups on everything but I’m not hitting my gross profit margin again. So exactly what Jamie is saying, that can definitely happen. We've got a lot of bench time, and the bench time is eating your gross profit. So it could be equally as bad as a write down, if not managed properly.

Jamie Nau: I think that's a great point. I think that's both those things are equal because I think I've had a lot of clients come in and go, look at all of these write ups I am getting, and they are celebrating and I get it. It's nice to beat your estimates on a project, but when it comes to planning the whole company and your pricing model, both of those things are obviously off if you are having a lot of write ups or write downs.

Jody Gruden: Another thing too, when looking at the different type of work you're doing, if I'm actually doing a lot of service work, retainer based service work, you know, I'm not going to want a whole lot of write ups during that time. I am going to want to make sure that I spend maybe even more time in that service work to make sure I at least bill when I'm there because do the extra legwork there and you're going to have a client forever. If your goal is on your service work to get it done as quick as you can and get that highest margins you can, you're going to probably lose clients. So I think it's really important to, maybe even over serve a little bit on your reoccurring revenue work, and I think you're going to come out the long run. I'm not saying take a loss or anything like that. I'm just saying make sure that write up, write downs within 5 to 10 percent as opposed having 50 percent write up because you didn't have a whole lot to do this month. So you didn't do anything. That to me, that it goes a longer way if you're actually spending money, maybe doing a couple extra things for that that client that maybe you wouldn't have done. Little perks. I think that's going to go a long way in client retention and client relationships.

Jamie Nau: Yeah, and I know we had a podcast on recurring revenue, but this is actually what Jody is talking about. It is like, you know, the reason recurring revenue is so awesome is because it keeps happening, keeps recurring. So if you could make that recurring revenue, if you can make your recurring revenues average 24 months versus 12 months, then that's what you want. And so if you sign up for that recurring revenue and then you're under serving them for twelve months, then you're like, wow, what are paying for? I only talk to them once a week and they are not there. So you want to make sure that you're still paying attention to them. And in those months where they're not asking for much reach out to. Say, hey is there anything we can help with? Or maybe it's the time to do that patch that you've been thinking about. Really track those hours on a monthly basis. Know that in the last two months we've had some write ups on this. Maybe this third month we should do something. We should do something to keep that client happy because it's the value of recurring revenue is the time for sure. Not the dollar amount pressure.

Jody Grunden: 100% agree.

Jamie Nau: Cool. So any final thoughts? I think we've talked a lot here and hopefully people are taking notes quickly. But any final thoughts for the listeners?

Jody Grunden: I would just say make sure you know what it is. Manage it on a weekly or monthly basis, know what your average bill rate it. Know what your average bill rate is per project. It's a very important tool that you have in your tool bag to actually help your bottom line profit margin. So knowing how much it needs to be. Managing it on a regular basis, and then making corrective actions when you don't have to. I think those are key.

Jamie Nau: Yeah, definitely. I think the more people that know the better. Your PMs can be the only ones that knowing. Your sales team should know. Your CEO, your CFO should know. Anybody within organization should know what that average bill rate is because they all take part in it. Don't keep it secret. Don't keep it close to the vest, because it is really important for everybody to know each project, how they're performing.

Jody Grunden: For sure.

Jamie Nau: Great. Well, appreciate you joining me, Jody. I think that was a really good topic.