For owners and operators of service-based businesses, growing pains are inevitable. But there are tried and tested formulas for understanding the right triggers or actions to take to ensure the growth in your agency is sustainable from both a workflow perspective and a cash flow perspective.
In this article, we tackle the important question of when you can afford to hire your next employee – because hiring at the right time is the difference between creating an unprofitable monster or building a cash-generating machine.
In this article:
When is the right time to hire?
As service-based business owners, how do you know when it’s the right time to hire? It’s based on gut feel most of the time. You might hire based on how busy you are, or your current backlog of projects, or because your team is getting burned out.
But running your business on gut feel can only get you so far. If you’re anything like me, your ability to make good decisions directly correlates to how you’re feeling that day. If I’m feeling optimistic, I feel rich. I feel like there’s opportunity everywhere. And then I get trigger happy and start hiring a bunch of people, who inevitably sit there with nothing to do… except eat away at my margin.
If I’m feeling like crap, I’m very conservative. I start penny pinching, and am generally not a great person to be around. This pushes the limits of our team members, which can lead to burnout and unhappy staff that end up looking for their next opportunity.
What we need is to shift our decision-making framework to a more stoic, systematic approach.
We call this hiring economics.
The costs of hiring
Employees need time to get up and running. They’re not machines that are instantly productive with a flick of a switch. They need time to adjust into their role. The costs of time, as well as the resources and energy to get there, put constraints on your business.
The effort that your team spends could be used to generate revenue. The result is that the costs of your new hires can outweigh your revenue growth. This can lead to little or no new profit – or in the worst case scenario, it can lead to losses.
It’s important to factor enough revenue to not only cover the costs of the new hire, but also the indirect costs of training, ramp-up and so on.
Finding that magic number
So, how much revenue or cash is “enough” to justify that new hire?
The rule of thumb is that you should have at least two times the new hire’s monthly salary in the pipeline. For example, if your new hire costs $10,000 a month in salary and super, you should have at least $20,000 per month of committed sales.
This revenue should be committed/sold before signing the employment contract.
The risk of not having enough revenue to support your new hires is that you erode your profit, meaning that the costs incurred for each new staff member erodes all the potential profit generated from your new sales. If this cycle continues, you run the risk of growing revenue and headcount with no actual profit.
This diagram shows a business that hires its new team members on ‘gut feel’. Every time sales grow, the business hires an additional team member to service those new customers.
Now, contrast this to the systematic approach to hiring. Every time sales grow, the business hires an additional team member to service those new customers – but at the right time, so that the profit is realised and retained.
The first rule of hiring economics is to have two months of the cost of the new employee’s salary as committed revenue. This is to ensure you are hiring profitably.
Note: This can be a juggle – a chicken and egg scenario, if you will. You don’t want to commit to work without the talent and you don’t want the talent without the work. One way to make sure you’re all-systems-go on hiring without signing the contract is to do the early recruitment phases first (i.e. job ad up, applications in) and then pull the trigger on interviews once you’ve got revenue in place. Whether or not this is relevant is going to depend if you’re adding a new service or expanding an existing service – but you get the idea.
Revenue vs cash flow
OK, so that’s revenue sorted – but what about cash flow? You know, the cold hard cash that’s required to pay your staff and keep the lights on.
The second rule of the profitable hiring formula is that you should have two months of cash in the bank for every new hire you’re looking to take on. Using the same example, if your new hire costs $10,000 per month in salaries, you should have a spare $20,000 per month in cash. This covers for ramp-up, and also for any slow-paying customers.
And that’s it.
So next time you’re wondering if you can afford to hire that new employee, go back to the two golden rules of hiring economics. Doing this will ensure you will grow profitably, not grow broke.
Got questions about this tactic? Get in touch for a free strategy consultation.