Improving Financial Security

Hi everyone. Great to have you all here. There's still some people joining, but let's start. Today we're going to talk about increasing financial security. This is a topic of interest for almost every micro or startup consultancy founder I meet. Before we dive into how we can measure and what you can do to improve the financial security of your consultancy, let's get clear on what it means. Before I forget, feel free to put questions in the chat and we'll go through them at the end. Right?

What do I mean by financial security? Here I added my personal definition. Achieving financial security means being able to ensure sustainable business operations, afford growth initiatives, protect against economic uncertainties, and support the personal financial well being of the partners or founder, right? And we can already see some important insights here just by looking at this clear definition.

First, it's not only about survival. The first, and maybe the biggest objective is to have enough cash for your operations. Survival does come before growth, right? But that's not the only goal you should have when you're thinking about financial security. You also have to fund growth initiatives, be ready to resist unexpected bumps, and also support your preferred lifestyle, right? That's the whole reason why you decided to start an independent consulting practice in the first place.

Second, it's subjective. So when we look at those things here, it's clear that what one consultancy considers a "financially secure" situation might be completely different from what others do, right? A firm with staff and office space has higher fixed costs than one person, remote consultancy, for example. So they will need more cash to support operations. If you have an effective marketing engine, a strong positioning, well-packaged offerings, you will also need to invest less money to attract more opportunities. Another example, if you, as a founder or partner, you want your business to fund a more comfortable or even extravagant lifestyle, then achieving financial security for you will require much more cash than if you are used to, or if you are willing to live with little and you don't pay yourself much, right?

Another thing we can take from this definition here is that financial security, it's not a binary thing. Financial security is not something that you achieve. It's not a yes or no thing where you are either financially robust or not. There's a spectrum, right? You can improve your financial security over time. For example, if you go from having enough cash to pay your bills this month to having enough savings to survive for three months. That's progress, right? And of course, we might argue whether this is enough to consider yourself financially secure. And I'll soon present some benchmarks for consultancies. But in this case, it's clear that you improved your financial security. Right? If you go from zero cash reserves to a three month reserve.

And this takes us to the first question here of this chat. How can we measure financial security? How do you evaluate it? In the universe of solo consultancies, micro consultancies, startup boutique consultancies, there are three recommended indicators that can be combined to evaluate financial security. These are the indicators that we use. I will briefly talk about each one of them, how you can calculate it, provide some benchmarks for your practice, and then we can explore what you can do to improve them.

The first indicator is client concentration. Client concentration issues are the number one source of financial security problems, financial turbulence, for smaller consultancies. It basically shows how reliant you are on your biggest clients.

Measuring this, it's quick, it's easy if you never did it before. These are the instructions here. Open a spreadsheet, list the names of all your clients and add next to them the total fee billings of each one of them, the revenue you're getting from them. Then you can remove the cost of associates, external contractors, any specific service you might have hired for those clients. If you have employees who are working exclusively for that client, you can remove their salary as well. But this will give you a rough estimate of the gross profit per client. Right? And then you just calculate the percentage of your gross profit each client represents. If you find it difficult to allocate costs per client, you can just simplify. You can just look at the revenue at your total billings and calculate what's the percentage of the billings per client, right. Looking at gross profit is better, but just calculating the percentage of revenue also works. And the important number here is the relative size of your largest client. Which in this example here, it's client three... He contributes to 48% of your gross profit. Roughly half of your gross profit is coming from one client.

Now, when exactly do you know you have a problem? Here, I added some benchmarks. If your consultancy's biggest client represents more than 25% of your gross profit, then we often say that your client concentration deserves some attention. If it represents more than 35%, then your client concentration deserves urgent attention. These numbers are backed by research. For those of you who want to check this in detail, David C. Baker wrote a book about it. Basically, his research shows that 35% is the median at which half of the firms fail. So if your biggest client represents 35% of your gross profit and you lose him, half the firms survive and half the firms fail, basically. So it's a head of tails, your chance of survival.

And this is not very encouraging, especially for smaller consultancies. As you see, we often need more clients. It might be the case you simply need more clients. If you have less than three clients, then by definition you have a client concentration problem, right? I recommend you to measure and check your client concentration at least twice a year.

But to keep this chat here short, I'm not going to talk about how exactly to manage a client concentration problem. If you have one, there's a specific process I recommend, and I wrote a bit about it in a newsletter edition a couple of months ago. I will share the link with you with the recording of this chat if you're interested. Now, let's go to the second metric.

And the second metric you can use to evaluate financial security for your consultancy is much simpler. We call it months of cash.

So, to calculate this is really simple. You add up all your normal fixed expenses for the year. Salaries, rent, equipment, software that are not specifically hired for individual projects. Remember to add your own salary or monthly compensation, of course. And you add it all up and divide the number by twelve months. And this will give you the monthly overhead. And then you simply compare this number with your total cash balance in the bank account. How much cash you have right now. This will give you the number of months of cash you have. If there's no cash coming in, if there's no new money coming in, how many months you can survive with the reserves with the financial reserves you have.

A healthy number for months of cash will depend on your specific context, market situation. As I said, it's subjective. But here are some benchmarks from the consulting industry as a whole. So you're vulnerable if you have less than three months of cash. In a fairly secure position if you have six to nine months of cash. And robust if you have over a year of cash.

I think that many consultancy founders, they underestimate that. Having a cash cushion is really good for business. It not only protects you from market changes or losing big clients, but it also provides you with more peace of mind. And this leads to better business decisions. When we feel we have our back against the wall and need to bring in a lot of money, and fast, then it's very difficult to exercise good judgment and really make the best decisions for our business.

Now, the third metric you can use is total debt, and more specifically, debt to asset ratio.

This is the least useful of the three for consultancies. And the reason for this is most consultancies do not use debt or financing. Consulting is a cash rich business, right? You barely need any capital to start a consulting practice. All you need is a decent computer and money to legally register your activity. And that's it. Of course, some consulting work requires in-person work, but even then, you rarely need expensive equipment or material, right? And when you do, you can always build clients for it. So the biggest cost in consulting really come down to people and real estate, if you rent an office space. So for most of you, it doesn't even make sense to calculate this.

First, you estimate your total assets. And you can do this quickly just by adding up the money you have in your bank, your receivables, which is the cash that you will receive in the future from signed contracts, and any depreciated assets that you could eventually sell in case of an emergency. So IT equipment, or furniture, or even a car if you use it only for work and it's in the name of the company. Second, you estimate the debt. So here you add up any debt you have with banks or individuals and other payables. So things that you already committed to pay in the future. For example, if you have a one-year office rent, for example, and it's $2,000 a month, then you have a $24,000 payables for the next twelve months. And then you simply check the debt to asset ratio.

And here in terms of benchmarks, if you're over 60%, you're vulnerable. It will be very difficult for you to get credit if you need it, in a commercial bank. You're fairly secure if it's between 30% to 40% and you're robust if you're under 20%. For most micro consultancies out there, you start to look more at this when you start building a team. So maybe when you're over 300, 400,000 revenue a year, you will have some payables, not much, but still, it's worth checking maybe once a year or before you make any big decision in terms of renting space or buying expensive equipment.

So these are the three main indicators we found the best to evaluate a consultancy's financial security. If you're doing less than a million a year in revenue, right? Client concentration, months of cash and debt to asset ratio.

A quick reminder here. When we run an assessment, our professional assessment for consultancies, we look not only at financial security, but also the financial performance. To have a complete picture of your practice, we also need to look at things like revenue pipeline, cost of client acquisition and so on. And today we're only talking about financial security. That's why I did not bring up those other indicators. But you do need to consider them when you're looking at your business, when you're kind of getting a big picture of your business.

Now, the last question I want to touch on here before we open our Q&A is the title of the chat. How do you actually improve financial security? The question will depend on your specific context again, and your consultancy situation. For each one of those three indicators we talked about. What I'm going to share here are the practical initiatives that most consultancies find useful. Starting from the quickest actions you can take.

Immediately you can cut superfluous expenses. This is the quickest action you can perform, right, cutting unnecessary expenses. It can be as effective as finding new revenue. Every dollar saved is a dollar earned. So that's really easy to do. Print your monthly bank account statement or credit card history for one or two months and you highlight the expenses. There's always something that you can cut out. Most founders, they are quite frugal. So it's better to start with the business expenses first instead of your personal ones. Subscriptions to software, for example, online tools, it's usually a big one. Last year we ran an informal poll, survey and we found out that consultancies with less than ten full time employees, they were paying for an average of 16 SaaS, 16 softwares as a service. And of course many of those were not being used or could be replaced by fewer and cheaper ones. Right? And it might seem like it's not much, but $600 $700 a month, it adds up to $8,000 or $9,000 a year. You can do a lot with $8,000 if you invest it wisely in terms of marketing campaigns, improving branding, etc.

I put this first, cutting expenses, for two reasons. First, there's a limit to how much you can cut, right? So yes, revisit and cut expenses once or twice a year. It will alleviate short term stress, financial stress, but it's almost always not enough by itself, right? And second, it also tends to put you in a scarcity mindset. A friend once told me, "frugality is not about being cheap, it's about being clever." I love that. So keep that in mind. Yes, cut. There's a limit to how much you can cut, but it can really help when we're looking at immediate actions. There's a lot of quick wins, quick dollars you can find in useless expenses there that you can avoid.

The second action is to set up an automatic savings plan. And this is also very easy and quick to do. You create a savings account. If you don't have one every month, you will send a percentage of your invoices, right? Or every cash that comes in to that account. Following the best practices from personal finance. The trick here is to set up a bank order to do it automatically. And this means you don't even see the money in your main account, right? And somehow, magically, we all figure out a way to do more with less when you don't see that money coming in. Now, how much exactly should you set aside will of course depend on your situation. But if you know your monthly overhead and have a "months of cash" target, for example, and you know the urgency of your situation, then it should be easy to plan to calculate how aggressively you should save.

So these are the immediate actions. Then we have a set of actions that you can perform in 30 to 60 days.

The first one is reducing internal capacity by outsourcing. Many partners look at outsourcing as a cheaper alternative to hiring in-house, to hiring internally. That may be true for some functions, but the key here is to remember that outsourcing is not just a cost saving strategy, but it's also a way to increase your financial resilience. You're converting fixed costs into variable ones. Most of you who are here do not have a large internal team. I see here that there are several who are soloists, or have one or two assistants to support. But some of you who are making more than 300, 400, 500,000 a year, you started to put together a team and you might have four, five, six people helping.

And if that's the case, and you have identified that you have low financial security... You're in a tricky place. There are risks. You can and should fire fast and reduce capacity. Check for low utilization. You can maybe speak to those team members or to those people and find an agreement to work with them on an ad hoc basis. Paying them more, but only when you need. In business, it's not always the biggest that survive, right? But those who are prepared for the bumps in the road. So it's not about the size. Don't be afraid, don't try to avoid reducing capacity. Maybe it's the right thing to do. Especially if you have identified that you have a low financial security in your consultancy. It's better to be safe than sorry.

The second action here, add top line by correcting prices. And here, changing your pricing strategy is the fastest way to grow your consulting practice. And the reason is simple. It doesn't require any time, money or people to implement the change. You can just change your prices from one day to the other. You can bump your prices up 10 or 15% for new clients and you start reaping the benefits immediately.

Of course, it's easier said than done. You need to justify your price with value. And strengthening your pricing is a long term process. But research, and I saw one from Benchpress recently, it shows that consultancies are way too slow to adjust prices. If I'm not mistaken, only one in ten consultancies, boutique consultancies, have client contracts that allow for price increases in line with inflation. So nine out of ten boutique consultancies were actually losing purchase power due to inflation. Chances are it's really time for you to make some kind of correction. I'm not speaking about bumping your prices up 30, 40, 50%, doubling your prices. I'm not speaking about that. I'm talking about some kind of correction.

We don't have time to get into details about it here, but there's not a universal recipe to raise your fees. Again, I saw a recent research by Consulting Success on fees, on pricing, and half of the consultancy founders say there's nothing really holding them back from raising fees. They just don't know how to do it or they lack the confidence. And for the remaining half, so half of the half, 25%, they are not raising fees because they're afraid of losing clients. So the plan will be different if you have lots of clients. If you have few clients, but a high concentration issue. So if you're relying on one big client. If your service offerings have long or short duration, etc. The plan will be different. Again, strengthening pricing takes a long time and it usually requires big changes in your strategy, in your consultancy. But there are ways to make small increases that will make a big difference in your bottom line and by consequence, increase your financial security. So that's something that you can look at in 30 to 60 days, making a correction to your price.

Third action here is cash in future profits. So this is especially important for those of you who use monthly retainers with clients. So with a retainer you're working with and you're billing clients every month. It's recurring revenue. And the thing is, if you are under financial stress, those long contracts, they don't help much profit. Profit is an illusion if it doesn't translate into cash flow, right? You can't spend profits that don't reach your bank, basically. So what you might do here is to offer some kind of discount or benefit for retainer clients to pay upfront. And it's as simple as it sounds. You can say, "For this six month retainer, our monthly fees are X or you can have a 5% discount if you pay it all upfront." Ideally, you want to do this only with existing clients. If you consider this, please check the recording of our last BCC Bites we did on how to do discounting right, "Alternatives to discounting". Because there are some important ideas there and I explored why exactly you should prioritize existing and loyal clients when discounting.

Finally, in 90 days, we have here "create new opportunities with current clients" and "chase qualified referrals." If we're looking at short term client acquisition, the better and faster opportunities come from either inbound or referrals and repeated business. For 99% of you, I would avoid cold outreach if you have a dry pipeline and are looking to win new projects fast, just because the effectiveness is lower. Chances are you will end up pitching for low-value, low-margin work that does not align with your positioning. It takes time to earn trust. So I would avoid cold outreach if you're in a situation of financial stress.

But 90 days is usually enough time to schedule time to explore new opportunities with your current clients, reconnect with those you already worked in the past, and also identify a few key referrals you can ask from your solid relationships. From your network. Ideally you want to have a process to do all of this, all of these things, right. But the key here is really to have a bias to action. Just invest as much time and energy as you can in business development and hopefully you will see results.

So that's it. As you see, not all of these initiatives might be relevant for you. Feel free to connect if you're interested in chatting about your own situation. But here, these initiatives here they are a good starting point to gradually improve the financial security of your consultancy. Now let's get to the questions.

John asks:

"How do I measure client concentration if I'm delivering projects to different departments in the same company?"

It's really simple, John. If you work with large corporations, large companies that have different departments or teams as clients, then you need to put them together. And let me come back here.When you're measuring client concentration and you're dividing by client, you need to put all of those departments and all of those client teams under one single client name. Even if you have multiple contacts who don't speak with each other. Even if these projects came from different sources.

And the reason is we're measuring risk here. And there is a significant risk, when you're dealing with larger companies, of losing multiple projects at the same time. This might happen, for example, if procurement changed the rules so they start to reduce the number of external consultancies they can hire, or they ask for new documentation, or they create new rules that you cannot comply with. It's really better to count different departments as one single client. Your risk of losing all of the accounts at once is significant enough not to be ignored, right?

Of course, there is quite a bit that you can do to avoid this in terms of client planning. Client planning is a process that we go through to identify how you can create new and larger opportunities inside your existing clients. Also diversifying your points of contact, etc. So there are ways you can mitigate that risk. But still, if we're measuring client concentration, you need to put them all into one single name. That's the most reliable way to measure financial security. There's no reason to fool yourself, right?

Okay, so that was it. Thanks everyone. I will share all the links to the resources, the newsletters, the recordings that I share here with you after the event. Please feel free to check our next events. Wish you a great week.

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