I work with MSPs all over the world. As a business coach I often get asked “What is the most important thing I can do to improve my business?” Those that work with me regularly know that the answer to that question will always involve financial management. Yes, “cash flow is king” as they say, but my primary goal when guiding MSPs is to lead them to a better understanding of their numbers. Let me explain.
Looking Back vs. Looking Ahead: Financial Management for MSPs
Every MSP has an accounting program they use to track income, expenses, and more. Smaller companies usually don’t spend much time analyzing the numbers and tend to look at their financial data “in hindsight”, meaning they review past data to see how they performed. In contrast, the most professional and fast growing companies I work with “look ahead”. This forward-thinking approach gives them indications of success early enough to make operational changes. Let’s take a look at some examples.
Comparing MSP Basic vs. MSP Grande
The small MSP, let’s call them “MSP Basic,” looks at their numbers monthly and checks the revenue and the profit. Everything else gets overlooked, primarily because their MSP chart of accounts is not structured for detailed analysis. The other MSP, we will call them “MSP Grande,” looks at their numbers weekly. In addition to reviewing revenue and profit, MSP Grande can tell which product offerings made money, what percentage of their revenue was spent on sales and marketing, and what their profitability is per product or department. They can also identify specific line items that need adjustment to improve performance.
Aligning Your MSP Chart of Accounts
So, what is the most important task? Aligning your MSP chart of accounts. You may ask, “What do I need to align it with?” Service Leadership provides a standard structure that many MSPs use, but there is nothing magical about it. Their structure simply breaks each category down so that you can measure individual components. Another advantage of using Service Leadership is that they provide quarterly benchmarks on how best-in-class companies are performing. (You will need a subscription to their SLI product to access this data). However, even without Service Leadership, structuring your MSP chart of accounts in a similar way can offer significant benefits.
Best Practices for Structuring Your MSP Chart of Accounts
While you’ll need a good CPA versed in Managed Services accounting to build out a complete MSP chart of accounts, here are a few key points to help you validate if you’re on the right track:
- Break Down Revenue Categories.
Make sure your revenue is categorized between products and services, and then further broken down under services to track each individual offering (i.e., managed services, security services, break/fix).
- Create Corresponding COGS Categories.
For each revenue category, you should have a corresponding Cost of Goods Sold (COGS) category. COGS are usually divided into hard COGS (software, subscriptions, etc.) and labor COGS (labor paid to service that product).
- Calculate Gross Margin.
Ensure you can calculate a “gross margin,” which is a simple formula: (product revenue – COGS = gross margin). Then, divide the gross margin by the revenue for that category to get a gross margin percentage for each product or service.
- Track Multiple of Service Wages.
You should calculate Multiple of Service Wages—a metric that divides total labor costs by total service revenue. This will tell you if your business is overstaffed. (See our blog post on this topic for a better explanation).
- Categorize Expenses.
Sales, marketing, and administrative expenses, along with labor costs, should all be categorized below the gross profit line.
Moving from Financial Tracking to Forecasting
Once your MSP chart of accounts is properly aligned, you should be able to track gross margin per product, measure sales and marketing costs, and assess administrative expenses as a percentage of gross margin and/or revenue. A quick search online will provide “best-in-class” benchmarks for MSPs in your area or nationally.
When you become proficient in measuring these metrics, aim to track them weekly. If a number is off, you’ll have time to address the issue before the month or quarter ends. This is the beginning of forecasting, which MSP Grande has been doing for some time now.
Conclusion: The Path to Growth for MSPs
Spend more time analyzing your numbers, and you will begin to see growth. Aligning your MSP chart of accounts is the first step to better financial management. If you need help, contact us, and we can have a conversation about how to improve your business’s financial performance.
If you need help, contact us, and we can have a conversation about how to improve your MSP’s financial performance.