The financial KPIs every professional services firm needs

When an investor approaches you with interest in your company, can you give them detailed insights about the business’s financial health? Or do you say “Oh, we’re growing fast” without any specifics? Be honest. If you don’t have a CFO or you haven’t been analysing your financial data, you don’t really know how your organisation is faring financially.

By establishing key performance indicators (KPIs), you can quantitatively measure your debt-to-equity ratio, customer retention, and other important statistics. This allows you to create realistic projections. With a keen understanding of financial health, you will also spot red flags a lot faster and may be able to change course in time to avoid disaster.

Essential KPIs

• Total revenue
• Gross profit
• Net income
• Clients as a % of revenue
• MRR billed in month
• MRR collected in month
• Average retainer or project size
• Number of clients billed in month
• Average AR collection period
• Utilisation and lock-up
• Salaries as a % of revenue
• Operating expense growth

Visory has worked with law firms, architecture firms, medical practices, marketing agencies and other professional services firms. This guide draws on that experience and on the benchmark data we have built up along the way, which we keep anonymised and confidential.

Let’s talk about why your company needs KPIs and how to measure them.

Why businesses need KPIs

Business founders have lofty goals for their companies. But how do you get there? Setting critical success factors and key performance indicators gives you a roadmap.

Critical success factors (CSF) are the activities that are necessary for you to achieve growth and success. These may include generating strong cash flow and increasing profitability. The KPIs of your organisation are the tools you use to measure your progress. If your CSF is customer retention, your KPI may be “Renew 90% of retainers due this quarter.”

KPIs should be clear and reasonable. But that’s not all. A good KPI is SMARTT: Specific, Measurable, Achievable, Relevant, Targeted, and Timeframed.

Your business needs KPIs to gain insights into the financial trends in your company. They may help you identify areas of struggle where you thought you were doing well. You may realise you can’t scale up as quickly as you thought you could and need to re-evaluate your projections.

Many businesses measure their success against an industry standard, also called a benchmark. Benchmarking can also refer to comparing your KPI measurements against a competitor.

Healthy KPI benchmarks vary by industry. Benchmarks related to customer satisfaction and profitability growth may remain consistent across industries, but realistic goals will depend on the market trends in your field.

Essential KPIs

Here are the financial KPIs that matter most for a professional services firm, and how to measure each.

Total revenue

The simple formula for measuring revenue is: total number of units sold multiplied by the average price. If you sell 100 units at $2, your revenue is $200. Expenses are then subtracted to determine your company’s net profit for the period being analysed.

As a KPI, revenue can be measured as:

• Revenue growth month on month (%). The growth of your revenue, month over month, as a percentage increase or decrease. A realistic goal for increasing revenue each month may depend on your industry.

Gross profit

Your company’s gross profit, also called gross income, is equal to the revenue minus the cost of goods sold (COGS). You may also measure your gross profit margin. Gross profit margin = (revenue − COGS) ÷ revenue × 100. For $200 revenue and $120 COGS, the margin is ($200 − $120) ÷ $200 × 100 = 40%. This is the share left after delivery costs, before overheads, finance costs and tax.

A gross profit KPI can be measured as:

• Gross profit month on month (%). The increase or decrease of your gross profit month over month can reveal whether a particular service is trending in the right direction. Aim to increase your gross profit by a modest margin every month to scale realistically.

Net income

Gross profit is revenue less the cost of goods or services sold. Loan principal and other liabilities are not deductions in this calculation. Net income is the bottom line after all expenses. Your net income takes your sales figures and subtracts your COGS, taxes, operating expenses, depreciation, and other business costs.

Where your gross profit can reveal if you are maximising your potential profits, net income reveals if your business’s finances are generally well managed. How profitable are you overall?

Your net income KPI can be quantified as:

• Net income growth month on month (%). If your net income begins to decline, it may indicate inefficient spending or a drop in sales. Steady increases suggest promising future profitability. As with revenue, the KPI goal for net income is usually set as small incremental goals over time.

Clients as a % of revenue

It makes sense for professional services firms to diversify their client base. If one client makes up the majority of your income, could you survive without them? Understanding each client as a percentage of your total revenue helps you identify when you need to add new substantial streams of income.

The general school of thought is that no one client should make up more than 10 to 15% of your total revenue. If a client takes up more of your revenue than that, you may be financially unstable if the relationship ends.

Each client as a percentage of your revenue can be calculated as:

• Client revenue ÷ total revenue. A higher figure indicates higher customer concentration, which can be a red flag. Depending on your industry and your current client revenue, you may want to set a KPI that reduces concentration by a few percentage points each quarter.

When you track clients as a percentage of revenue, you have more visibility into who contributes to your revenue. You can also trim clients that take up time but don’t contribute to your revenue in any significant way.

Monthly recurring revenue and billings

Monthly recurring revenue (MRR) is the monthly-normalised value of recurring contracts. It helps firms with ongoing retainers track their recurring revenue base. Exclude one-off projects and report their revenue separately.

A $12,000 annual recurring contract contributes $1,000 MRR, regardless of the month it is billed or paid. With 100 active recurring contracts at $100 a month, MRR is $10,000. Track recurring invoices raised separately: billing frequency can make that number different from MRR.

Review changes in MRR by new contracts, expansion, reductions and cancellations. A lower figure may reflect lost clients or a deliberate change in your client mix; it does not by itself identify the cause.

Cash collected from recurring invoices

Sum actual receipts allocated to the recurring invoices you are reviewing. Do not multiply the number of paid invoices by average revenue per client: clients can pay different amounts, part-pay or settle older invoices.

For example, two monthly retainers of $100 and $300 have average revenue of $200. If only the $100 invoice is paid, cash collected is $100, not $200. Compare receipts against the same invoice cohort and separately identify opening arrears, credits and advance payments.

Average retainer or project size

Increasing your retainer amounts improves your cash flow. It’s in most professional services firms’ best interests to measure and grow their retainer income. Likewise, increasing project sizes can warrant higher billables.

As a KPI, it often makes sense to measure retainer income often:

• Retainer or project growth month on month (%). Measuring retainer income and project size month by month lets you identify trends. You can set goals incrementally, such as growing project size by 2% each month.

Some professional services firms operate on a retainer model, some charge a project fee, and some do both.

• Retainer: a recurring monthly or quarterly agreement between a client and a firm for specified services or advice.
• Project: one-off work for a defined period with the client.

If you are operating with a retainer pricing strategy, you want to track the retainer size and its growth over time, especially to keep pace with inflation. When you increase your retainer size, your overall revenue will increase. You need to take on fewer new clients and can instead keep growing revenue efficiently with higher retainer rates for consistent services.

Number of clients billed in month

This KPI is related to your clients as a percentage of revenue. As you steadily increase the number of clients billed each month, you diversify your cash flow sources. You also increase your chances of successful referrals.

Client growth is often measured as a percentage increase between two time periods:

• Client growth month on month (%). KPIs are set as a percentage increase month over month. You may also have a year-end goal for the total number of clients on your roster.

For professional services firms, this one is simple. How many clients are you working with? How has this number changed as you’ve increased your retainer or project fees? Do you need more clients to hit your revenue goals, or can you grow with your existing clients?

Average AR collection period

Professional services firms set a due date for their invoices. Often invoices are due on 30 or 60 day terms, meaning that the total balance must be paid within 30 or 60 days. The shorter your collection period, the more efficiently your accounts receivable runs.

Your average accounts receivable collection period is often referred to as days sales outstanding, or DSO. DSO = (trade debtors excluding GST ÷ revenue for the period) × days in the period.

KPIs for days to collection are measured in time:

• Number of days to collection. For firms with 30 day terms, the average number of days to collection should be no more than 30. Ideally, you would have a collection period of under 30 days, indicating that your collection efforts work and you are paid early. A reasonable KPI for collection is to aim for all invoices to be paid on time.

For a professional services firm, this metric is a working-capital measure: it shows how quickly the business turns invoices into cash.

Ultimately, the average collection period depends on the terms in your contract with each client and the time allowed to collect a payment, as well as any fees for paying late.

Utilisation and lock-up

Two KPIs are specific to firms that sell time. Utilisation shows how much of the team’s available time is billed to clients: utilisation (%) = billable hours ÷ available hours × 100. Track it by person and by team, and treat a falling figure as an early sign of idle capacity or unbilled work.

Lock-up measures how long fee revenue sits in work in progress and unpaid invoices before it becomes cash: lock-up days = (work in progress + trade debtors) ÷ annual fee revenue × 365. A rising figure means the firm is funding its clients; bring it down by billing work as it is done and chasing debtors promptly.

Salaries as a % of revenue

Salaries can take up a significant share of revenue, limiting net profit. Calculating your organisation’s salaries as a percentage of revenue is easy: payroll percentage = (total payroll expenses ÷ gross revenue) × 100.

Your KPIs for salaries to revenue are measured as a percentage:

• Salaries to revenue year on year (%). Salaries are measured over longer terms than most other figures. If you are spending 50% of your revenue on salaries, set a goal to reduce the ratio by this time next year.

The right range varies widely with the firm’s model. A firm that relies heavily on senior talent will carry a higher salary expense; a firm that outsources work or can scale without hiring will carry a lower one.

As a rule of thumb, businesses in general aim to keep payroll between 15 and 30% of revenue. Where people are the product, as they are in most professional services firms, 40 to 50% can still be profitable. The useful measure is the trend in your own payroll percentage, tracked year on year.

Operating expense growth

Operating expenses range from payroll and office supplies to the rent you pay for your office and the utility bill to keep the lights on. As you expand your company, operating expenses naturally grow. Figuring out how quickly to increase your spending is key.

Creating a realistic budget for your organisation hinges on making sure you don’t spend too much too fast.

Operating expense KPIs can be measured by monthly increase goals:

• Operating expense growth month on month (%). Tracking your expenses month over month is the best way to see spending trends and measure goals. Set a maximum monthly percentage growth for your operating costs.

KPI summary

Key performance indicators give your company a tangible way to see if you are thriving or flailing. The more real data you can give your CFO and accounting team, the better their analysis will be.

So, are you confident in your KPIs and financial reporting? If you’re not quite sure where to start, a discovery call is a good place to begin.