How to evaluate your revenue sources
As the economy rapidly changes and previously dependable revenue sources dry up, it’s crucial to understand your business model and how you generate revenue. Revenue generation is one of the most important elements of continued business success. But, are you managing it wisely?
Profitable, well-run firms use a systematic, information-driven approach to diversify their revenue profile. Let’s discuss the metrics and methods to effectively evaluate your firm’s revenue sources.
The first step to evaluating your firm’s revenue is understanding the source. It’s important to know what clients are paying for, who is paying, when, and how much. Knowing the answers to these questions will help you forecast your future revenue potential and can serve as the basis for informed decision-making.
As you identify the who, what, when, and how much, it is equally important to categorize them accordingly. The first two elements, the who and what, carry added significance because each needs to be well-diversified to ensure longevity in your firm. We’ve all heard the saying, “Don’t put all of your eggs in one basket.” That’s because a proper revenue diversification strategy minimizes your firm’s dependency on a sole revenue source or client.
You will want to frame the last two elements – when and how much – based on how you categorize your clients and your services.
Let’s map out a clear revenue evaluation strategy.
We’ll start with your service/product offerings (the what), since you have the most control over that.
Evaluating your services (the what)
As you evaluate your services, consider whether they are consistent with your firm’s overall revenue goals. It’s a good idea to separate your services first by the type of service, and then by client. Here, we’ll discuss the services.
Consider the following metrics when reviewing your service revenue on your income statement:
- Total service revenue ($): Total revenue generated by all
- Revenue by service ($): Amount of revenue generated by each
- Revenue by service tier ($): If you have different levels of services that you provide (i.e., starter, intermediate, enterprise), you will want to look at how much revenue each generates. This can be found on QuickBooks’® “Sales by product/service summary” report.
- Revenue by period ($): QuickBooks has two great reports: “Profit and loss by month” and “Profit and loss by quarter.” Both will help you determine seasonality, as you can see how much each service generates and when.
- Service revenue as % of total revenue: Again, QuickBooks provides a report called “Profit and loss as % of total Income,” which spells out what percentage of your total revenue comes from each service.
Using these metrics will be the baseline for determining how revenue flows into your company. You will be able to understand which services generate the most revenue, and then drill down to see which tier of service is your highest producer in dollar value and percentage of revenue.
Now that you know how much each service generates, let’s examine who you’re servicing.
Evaluating your clients (the who)
Clients can differ in size, industry, types of services, and service effort. Each can affect how much revenue you generate and when you collect it, so you will want to quantify each.
One of the best ways to evaluate how much each client generates is to look at the “Profit and loss by customer” report in QuickBooks. You will be able to identify your largest clients and how much they generate in total dollar amounts and percentage of revenue. Going further, you should also evaluate your clients’ company size by revenue, industry, and the level of effort required to service them.
How you determine small vs. large will depend on your firm, but a good arbitrary split would be $1 million in sales. Once a client crosses the $1 million threshold, total revenue can vary widely, but so can the amount of work.
Smaller clients will often require a lower service tier, as opposed to a larger organization that has a high volume of complex transactions. This is when the “Sales by product/service summary” reports, mentioned above, come in handy. The report will call out where your clients are concentrated. For example, your smaller clients may be concentrated in your lowest service tier, while large clients are in your highest tier. Smaller clients often have common recurring transactions that are easier to manage, but may not generate as much revenue for your firm. Larger clients tend to stick around longer and generate more revenue over a longer period.
When looking at your revenue sources, you will want to consider how each client industry plays into your overall revenue goals. Clients in different industries have different seasonality and may require more or less complex services. Looking at the “Profit and Loss by Period” reports will identify any seasonality in your services caused by your clients. For this reason, it is important to diversify your client industries to ensure revenue is generated year-round. Going further, economic situations affect industries differently. Depending heavily on clients in vulnerable industries can affect your overall revenue and firm in the event of a crisis within an industry.
Every client will require a different level of service, due to the complexity of their business, or, unfortunately, the complexity of dealing with the actual client. This metric is not presented on a report per se, but can be determined with a simple in-house grading system. You can start by creating a binary 5-point system that takes into account the ease of servicing the client. Add 1 if the task is easy, and 0 if it is difficult.
Consider the following, and grade them accordingly:
- Amount of effort needed to complete the client’s work
- The expected turnaround time
- The quality of the client’s documentation
- Your relationship with the client
- The ability to delegate the work
Once you’ve evaluated your revenue sources using the methods and metrics above, you will be better able to understand how revenue is generated within your firm, and how you can diversify your firm to maximize your revenue potential.