When it comes to business, let’s face it: most of us freelancers are kindof making it up as we go.
If we went to college or university, it wasn’t to get a business degree, it was in design, writing, marketing, development or some other craft.
So while we may be talented craftspeople, natural businesspeople we often are not. In fact we see this all the time as we coach freelancers on our podcast, Freelance to Founder. We talk with some of the most talented and creative freelancers who are living check to check in a feast-famine cycle.
It’s too bad.
So in an effort to help you better understand what it takes financially to run a thriving freelance business or agency, let’s talk numbers. (PS: This is not about “payment terms” which are the terms you put in your invoice to make sure you get paid on time. You can learn about payment terms here.)
Specifically, let’s talk about the metrics you should be watching extremely closely as a freelancer in order to have plenty in the bank (especially if you want to grow into an agency).
And for more freelancing terms you should probably know, check out our freelance term glossary.
1. Revenue
This may seem like a no-brainer, but above all else you HAVE to pay attention to revenue. Freelancers CAN become millionaires, but it all starts with top-line revenue.
It can be easy to get caught up in client deliverables, hitting deadlines, finding new clients, and all the other important tasks that make up your small business.
And before you know it, you forgot to check on your actual revenue. Invoices have gone past-due, you haven’t booked a new client in a few weeks, and you’re staring down a big problem: no cash flow.
Depending on the age of your business, checking in on revenue once a month or even once a week is simply not enough. If you’re trying to get your side-hustle or small business off the ground, you should check in on your revenue every day.
As things become more predictable, you can move to every other day, then every few days, then every week, and so on.
2. Profit Margin
Of course, even if your business in raking in the revenue, it doesn’t matter all that much if you’re not actually making a profit.
While many Silicone Valley startups have made it seem normal to delay making a profit, unless you’re going to raise millions to burn as you learn, then not generating a profit is simply not an option for you.
That’s why you have to know your profit margin.
Profit margin is expressed as a percentage. For example, you make 40% profit margin on average. You calculate profit margin with this simple formula:
(Net Profit / Revenue) x 100
In other words, the net profit you have left over after expenses, divided by the total revenue your company makes. Multiplied by one hundred and expressed as a percent.
Example: If I make $10,000 on a project (revenue) and I spend $2,000 on the project itself, I’m left with $8,000 (net profit). So the calculation would be as follows:
$8,000 / $10,000 = 0.8 x 100 = 80; or 80%. I would have 80% profit margin.
Smart business owners watch their profit margins carefully since it doesn’t matter how much money your business makes if you end up spending it all, unable to reinvest in growth or pay yourself.
3. Client Acquisition Cost
There are lots of freelance marketing strategies you can use to attract new clients.
But it’s important to know about how much it costs you to acquire a new client for each channel you experiment with.
This will help you establish your rates because, if it costs you $500 in time and money to bring in a client and you only charge them $600 for a project, you might think you’re making $600 when you’re really only netting $100.
That’s a big difference.
Ultimately, the client acquisition cost will help you assess the effectiveness of each of your marketing and sales tactics.
As you experiment with different marketing strategies, the goal is to find the channel that brings the best results for the lowest cost.
Of course, there are other things to consider as well, but these two factors are critical: best results; lowest cost.
3. Client Lifetime Value
In addition to knowing how much it costs for you to acquire a new client, you should know what the average lifetime value of a client is.
A client lifetime value is the total revenue you will make from a client from the time you start working together until you finish working together—otherwise known as the client lifetime.
Why? Because when you start to get really clear on how much it costs to get a client and how much you’ll make from a client you can start to scale your business and know that it will remain profitable.
It also helps you manage your client acquisition costs. If you know that your average client will bring you $5,000 in work and you want your profit margins to be at least 50%, then you know you can’t spend more than $2,500 in acquiring and working with that client.
4. Utilization Rate
Of course, all of this matters very little if you can’t stay booked enough to stay in business. That’s where your Utilization Rate comes in.
It’s the percentage of your billable hours compared to the total billable hours available. It’s important to note, this does not necessarily include non-billable hours. So if you work 40 hours per week, probably only 20-30 of them are actual billable hours since you’ll spend much of your time doing sales, marketing, networking, invoicing, project management, client management, and other administrative tasks.
So the question to ask yourself is: how many available billable hours am I filling up? The higher the number, the more revenue for your business.
5. Expenses
Almost as important as the revenue of your business is Revenue’s arch nemesis: Expenses. While revenue is money IN to your business, expenses are money OUT of your business.
This includes everything from the cost of new equipment to paying subcontractors to taking a client to lunch.
And while expenses can seem somewhat evil (“I spent HOW MUCH this month?!”), in reality, wise investments which are also expenses are the only true way to grow your business.
The key is to be wise with your expenses. Focus on spending money in places where you are likely to see a return on your investment (or ROI).
For example, spending money on marketing or advertising to bring in new clients. Or paying subcontractors to free up some of your time to network with potential clients.
When used intelligently, expenses don’t shrink a business, they grow it.
6. Tax Liability
There’s nothing more depressing that finishing up the first year of being in business for yourself and realizing you have to pay way more taxes than you thought.
In fact, if you’re making $80,000/year or more as a freelancer and you’re still a Sole Proprietor (instead of an LLC), you’ve got to fix that right away. There are companies like Collective or LegalZoom that can help you form an LLC and then execute something called an “S-Corp Election” which can save you thousands in taxes.
To avoid being shocked at the end of any financial year, you should stay up-to-date on your tax liability.
Tax liability is essentially a fancy word for how much you owe the government in taxes based on your personal and business income.
You can leverage tax deductions to save on taxes, but honestly: the smartest thing you can do is hire a good CPA. They’ll know all the ins-and-outs of tax law each year and be able to reduce your tax liability as much as possible so you can keep the highest amount of your hard-earned income as you can.
7. Portfolio Conversion Rate
If you’re like most freelancers, you’ve built an online portfolio. And, sadly, if you’re like most freelancers your online portfolio does not convert like you want it to.
What’s more, you may not even know what your portfolio conversion rate is. In other words, of the total number of people who visit your portfolio, how many of them become clients?
Here’s what the formula looks like:
Total New Clients from Portfolio / Total Portfolio Visitors = Portfolio Conversion Rate
To measure these kinds of metrics, you’ll need some sort of analytical tool like Google Analytics.
The reason this metric is meaningful is this: when you know your portfolio conversion rate, then you can do simple math on advertising and marketing to determine how much time/effort it will take to convert a new client.
For example, if 1/100 (or 1%) of your portfolio visitors converts to a client and you know each client brings in $1,000 on average (see above), then you can spend up to $10 per site visitor in order to break even on your new client. Of course, to make a profit, you’ll need to drive that client acquisition cost down.
See how all of these metrics build on each other? It’s a powerful thing.
8. Runway (Cushion)
Finally, one of my favorite and most important metrics: Runway.
When you’re growing a business, your runway is the total months or years you can stay in business at your current burn rate (how fast you spend money).
For example, if you have $10,000 in the bank and you spend $1,000/mo on your business, then your runway is 10 months.
The goal is to grow your runway—particularly when you’re a freelancer or small agency. Business owners who did this in 2020 were not put out of business by the Covid-19 pandemic. They were able to weather the storm and power through.
Whether or not another pandemic is coming is irrelevant. What matters is there will always be issues; personal illness, economic market shifts, seasonal demand changes, etc. If you have a nice runway (or cushion) you can work through the “down” times.
There are more…
Of course, there are lots more metrics you should know as a freelancer. Running a business is all about the numbers. You may have gotten into it for the fun, the passion, the freedom, the flexibility.
But it’s the metrics that KEEP you in business.
The better you know them, the more likely you are to stay in business for a nice long time.
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