In this article, I’ll have a go at explaining a measure of business efficiency which I heard described by Nic Rixon (if you ever get a chance to see this guy, do it) in a business growth seminar, which he calls a “Run Rate”. The term Run Rate is normally used to describe a company’s revenue extrapolated over time, but as I can’t find another term for this measure I’ll use Run Rate for now.
Imagine if everything was running at maximum efficiency. If you charge by the hour, this means every employee who does chargeable hours is working all day every day. Enough sales are being made to keep everyone busy, client expectations are managed so they don’t keep calling, maintenance is low because quality is high, cash flow is easy because prices are right, and staff are productive because they know what needs doing, and have the tools to do it. Perhaps you’re purely selling time, in which case imagine you could work chargeable hours every day. What would your sales figure be? Put a realistic number on it.
Now, what are your sales currently? Take the past 6 months, for example. Perhaps discount any abnormal windfalls or writeoffs, unless they happen regularly. Divide that by the previous figure for the same time period. For example, if you did £50,000 in the past 6 months, but you could potentially be doing £15,000 per month, then you could potentially have done £90,000 in the same time period. £50,000 / £90,000 is 0.55, or 55%.
The result (as a percentage) is your “run rate” – the ratio of actual sales to potential sales, and therefore a measure of how efficient the business is. Shocked at your figure? A well-run business can achieve a run rate of 70% or more – 100% is impossible to achieve because there are always unexpected problems, but if everything is working well, recurring issues are designed out or priced in, and the sales are coming in, most businesses can achieve 80%.
A run rate of under 45% is likely to lead to cashflow problems, simply because your expenses plus cost of sales are likely to be at least that proportion of turnover, which leads to hand-to-mouth cashflow. In hindsight, I can find several stages of different run rates in my first business:
- Initially as a 1-man-band, it was around 20%, for two reasons – I was terrible at estimating time (pricing too low), and focussed only on doing the delivery work (poor credit control). At one point I couldn’t afford to buy food, yet my future wife found £3000 worth of services I had not invoiced – just one of the many reasons I married her!
- Later, with staff and two very experienced mentors, both these things were controlled and the run rate grew quickly to around 60% and for the first time, I could take a salary.
- Towards the end, with more staff, a bigger office, customers dropping off due to the recession, and my time almost fully occupied by one customer, I lost some control and the run rate dropped to around 40%.
When your run rate is climbing above 70%, consider expanding. Taking on an office and more staff expanded the capacity of my business, but consider what it did to the run rate – suddenly there was a lot more capacity, but the extra sales aren’t there straight away, so the run rate dropped dramatically. That drop has been responsible for many companies collapsing, particularly in the past few years when sales and therefore run rates have grown slowly, or even dropped.
If you’re running a business that revolves around your technical skills, and you want to grow your income, make sure you learn to grow your business, and keep measuring it – eventually you’ll get an instinctive feel for where to focus resources and how to increase profit.