There is a really important business concept that ALL digital agency owners (in fact all business owners) should know of and work through in their business. It’s a concept, a number that turns your business dreams into a workable plan. It is the final piece in the business puzzle, the piece that lets you see the whole picture, so you know exactly what you need to do to achieve your business goals.

This concept is called “CAPITALISATION”. Capitalisation is the concept that tells you the exact number you need to spend to achieve your business goals. If you know this concept, and this number, wouldn’t it be useful in helping guide the strategic decisions you need to make in your business?

In this article, I am going to take you through the steps you can take to calculate the “capitalisation requirements” for your business.

Do You Know Your Numbers?

As digital agency owners, or professionals in the digital marketing industry, we are always asking/telling/expecting our clients to “know their numbers”. Yet, most of the digital agency owners I’ve talked to do not actively (and by actively I mean reviewing at least once per month minimum) collate, monitor and review their numbers.

“Why is that?” I’ve asked myself.

The answer I believe is that we do not understand the full picture of what our business numbers can give us, how powerful this knowledge is. As digital agency owners, we are marketing professionals. So when we think about “business numbers”, outside our P&L we only really think about the numbers that are of tactical use for our campaigns. Cost Per Click. Conversion Rate. Position on Google. Click Through Rate. Return on Ad Spend. 

These are the “numbers” that we live with. We think these things are the “end game” in business numbers. And as such, they become divorced from the higher level management of our business. Our agencies can then devolve to a string of campaigns with isolated, independent to each other results. As such, they become irrelevant to the bigger picture, so we stop tracking them.

At the end of this article, you should be able to see how all your business numbers tie together in a way that should become super supportive of the decision making process in your business, to the extent that they all but guarantee you can hit your goals. With that level of “business wisdom”, you may (like me) start getting super excited about your numbers and start living and breathing them. You will find a new level of intimacy with your business at this point, feeling its rhythms and patterns through the numbers, getting insights that no-one else can see or understand. So if this sounds like something that could be helpful, let’s get to it.

Step 1 – Your Agency Goals – Knowing What They Look Like

I find it quite funny in business how we set our goals. Most often, at a really common time (start of a new year, end of a financial year) we pick a random or popular number and assign our future to it. 6 figures. Half a million. 7 figures. Increase by 50%. Double this year. The list goes on! But that is where our goal setting ends. We don’t interrogate the number, we don’t seek to understand it, we literally have no idea what the number looks like in our business before blazing into the next period of business activity. 

(Insider tip: If you sell your digital agency, your buyer will pay a multiple of profit. So when setting your growth goals, profit is the key number to improve, not revenue. Make PROFIT your goal)

So what should you do? You should seek to understand your goal. To do this, just create a Profit and Loss Statement for what your business should look like when you hit your goal. This should give you a very clear picture of what your business will look like at that future point, and it will also give you a reference to create a logical budget in achieving that goal.

Some considerations in this your should think about:

• Am I chasing the correct goal (profit or revenue?)
• Are my business foundations sound enough to support the goal?
• Infrastructure – we always underestimate these costs and requirements as our business grows. Am I strong enough here?
• How do I resource product and service delivery as revenue ebbs and flows on the journey so excess capacity does not take all our working capital?
• Do I chase shiny objects and have I captured this in the P&L?

Step 2 – Ensure Your Pricing Supports Your Goal

A question. How did you strike your prices in your digital agency? 

When I ask this, the most common answer is expressed as a percentage or relative of average industry prices. Or based on what family/friends have suggested is a fair price. Or based on what a business coach (just as randomly) said you should do.

I have never met a digital agency owner who expressed that they set prices based on their cost structure and desired margin, worked out with an understanding of output probabilities of existing resources at a reasonable utilization rate. Yet this is the only way you should work out your prices, otherwise you will not even know whether your prices will cover your costs. They may not. If they don’t, the more successful you are the faster you will head towards bankruptcy.

Once you have created the Profit and Loss Report for what your agency looks like after you have achieved your goal, this is a great time to review your prices to ensure they actually support your goal. 

If you don’t know where to start with this, you can access my spreadsheet that I use to calculate our prices (and a bunch of other resources) by clicking here.

On a conceptual basis, what you need to do is set out your entire cost structure for your business at a given level of revenue. Your available human resource hours will be captured within those numbers. With those human resource hours, you need to calculate how many “units” or “products” you can fulfill. This is your capacity for your cost structure. With that detail you need to divide into your projected revenue, which will give you your minimum price per “unit”.

Here are some things to consider with this calculation:

• We often fail to measure hidden (but real costs) in our figures
  • Gifts and pro bono work
  • Internally resourced marketing
  • Owner time
• We forget to add desired margins into our pricing
• We always overestimate employee utilization rates
• We forget to include unintentional costs like bad debt

 

 

Step 3 – Calculate The Gap Between Today And Your Goal

Once you know what your goal looks like when it’s achieved (your projected P&L) and you have verified that your pricing strategy supports the goal, you can quantify the gap between your goal and where you are today.

This process is simple. The first part of this requires that you know some of your business numbers today. As I said, this part is simple. You should have these numbers at the tips of your fingertips already. If you do not, I’d suggest you have some pretty major problems with your business and you should seek some help from a coach, accountant or at the very least a bookkeeper.

These are the numbers you need to know for this step:

1. Your current annual profit (true profit if this is your goal)
2. Your current annual revenue (which is most people’s goal – and we will use here)
3. Your current number of paying clients
4. The number of leads/contacts who are subscribed in your database.

With these numbers, you need to calculate the difference between where you are today and your goal, and then using the percentage gap, extrapolate the growth you need to reach your goal in each of the metrics above. As mentioned above, I have a free calculator you can use for this, the link to access it is here:

An example of this though follows. For this hypothetical, let’s say your agency has annual revenue of $667,000 and you want to grow to $1,000,000 turnover this year. The difference between the business at these two levels is $333,000. This is 50% of where the agency is today (Ie. 50% of $667,000 is $333,000 – and yes I picked these numbers because the math is easy.)) So for your agency to hit your goal, it must grow by 50%. 

While this is not a perfect model, it will not be too far from reality to assume that if we need to grow our revenue by 50% to hit our goal, the other metrics will grow by 50% too. So calculating this out, at our goal our numbers would approximate:

Metric	Today	Goal	Required Growth
Revenue	$667,000	$1,000,000	$333,000
Clients	42	63	21
Leads	2,106	3,157	1,051

Having done this, we can now see that (all else being equal) we need to acquire 1,051 more leads, which should turn into 21 more clients, which as growth on our existing business, could get us to our goal of $1,000,000 revenue.

Though there are some other factors we must consider, and build into this model for it to be of more use.

• We need to cover attrition. If you know what % of clients you lose each year, you need to also replace these to achieve your goal. So add these as new clients to win, and work out how many additional leads you need to get those clients.
• Is your sales process tight and a process? If so you can be confident you should get predictable results with growth. If not, this modeling may not be predictable. 
• As you grow, lead quality can deteriorate. 
• Throughout the sales process, performance often deteriorates with growth. To effectively scale, you want to see sales performance improve.

Step 4 – Get To Your Real Cost Per Lead Acquisition

Your CPA (Cost Per Acquisition). 

Knowing this is a fundamental cornerstone to being in full control of your destiny. Not just in a marketing campaign, but the destiny of your entire agency. Yet despite knowing this, we rarely focus on it. And if we do focus on it, we rarely get it right at a business enterprise level. 

Why do we get it wrong? 

One of the main reasons we get it wrong is that being marketers ourselves, we fail to accurately assess and include in our calculations, the market value of the marketing inputs we make ourselves. We do not include the retail value of things like:

• Internally resourced marketing campaigns/consultations
• Owner hours in management of the marketing

Remember, the goal is not to get a Good Looking Number so you can celebrate how low our CPA is, it is to get accurate information that you can use to make wise decisions about your business.

So at the high level of your entire business’s marketing effort, include the retail cost of EVERY marketing and growth input and calculate an accurate cost per acquisition for your agency.

Step 5 – Calculate Your Capitalization Requirements and Make Wise Decisions

If you have read this far, well done! You now have everything you need to calculate the financial requirements to achieve your business goals. Here is the final step in working this out.

If you go back to Step 3, we worked out the number of leads we need, at our given lead to client conversion rate, to achieve our business goal. We also calculated the gap between this number of leads and the leads we currently are marketing to in our database. This gap is the key number. The number of new leads we need to acquire to achieve our goal.

(In the example above it was 1,051 new leads)

In Step 4, we calculated accurately, without ego, our cost per acquisition per lead. For the sake of this exercise, let us use $250 per lead as a reasonable CPA for a digital agency.

With these two figures, all we need to do now is multiply this out. If we need 1,051 leads and our current leads cost $250 each, we will need to spend $262,750 in marketing (including the retail rate of our internally supplied marketing) to get the leads we need, to convert to the clients we need, to generate the revenue and profits that align with our goal.

This is the basic premise for working out your capitalisation requirements. With this number (and I assume it may seem large the first time you run this process) you can start making wise decisions about how to fund this investment in marketing.

BUT, there is a core factor to consider when you start making decisions. This amount, when committed to and spent, will become part of your profit and loss as a marketing expense. So as you start planning this out you need to go back to Step 1 and adjust your Profit and Loss Statement to understand how it flows into profits (which as I said, should ultimately be your goal). Once done, you may need to adjust some elements of your model (pricing, revenue targets etc) to understand the reality of your goal.

It may take a few iterations to get this number right. If this is the case, do not worry, this is actually a great thing. You are becoming more intimate with your business and its fundamentals. You are becoming a better business person. So make the effort and do as many iterations as you need.

Once you are comfortable with your capitalisation amount, all you need to do now is decide how you will fund the required investment in marketing to achieve your goals. Here are some ideas:

• Client receipts – if your pricing, margins and cashflow permits. This is an ideal scenario
• Business optimisation – can you do this easier, quicker and cheaper by improving cashflow, improving profit per project, reducing your CPA?
• Reinvesting profits into marketing. Note – this is actually the same as the first bullet point. You are not “reinvesting” you are reducing profits by increasing marketing expenses.
• Owner investment or loan. Note – this funds the marketing efforts and the P&L will still be impacted by the increase in spend. An investment needs to be reflected with a greater holding of shares. A loan needs to be paid back with interest.
• A commercial loan
• An equity partner or investor
• Time – maybe you need to lengthen your goal time frame to make everything work.

In closing, be aware that most businesses (over 80%) are undercapitalised. (This is probably your business unless you have carried out this exercise.) This is the case as they likely have never heard of the concept, let alone understood it or gone through the process of working it out for their business. So I applaud you, you are now in the top 20% of business people in business knowledge. Now go make wise decisions and achieve your goals.

Don’t forget, I have a free calculator you can use to work through this entire process, the link to access it is here if you’d like a copy: