Key Financial Terms Every Design Firm Owner Should Know

While we all own and operate our own design firms, few of us actually received formal business education. Whether you recently launched an interior design startup or have been in business for decades, asking a peer or mentor what different business financial metrics mean can be embarrassing. We often feel like we should just know, even though design school taught us how to be designers – not business owners. As a business owner, it is crucial to have a solid understanding of key financial terms and track each metric. When you understand your firm’s complete financial picture, you can identify red flags and make informed decisions that will drive the success of your firm. From gross vs net profit to fixed vs variable costs, you’ll learn how to distinguish between all the metrics and KPIs that impact your business’s financial health. No matter where you are in your journey as a firm owner, it’s essential that you track each of these key performance indicators. In our next post, we’ll outline each of the many financial statements your firm should generate and analyze each month, quarter, or year. These include your cash flow statement, income statement, and more. For now, let’s get into all the financial metrics you should know and track!

What Are Key Performance Indicators?

Before we begin, let’s define key performance indicators KPIs. Key Performance Indicators provide valuable insights into a company’s financial health, performance, and trajectory. They allow design firm owners to make informed decisions and drive growth.

In simple terms, KPIs are measurable values that demonstrate how effectively a company is achieving its key objectives. These objectives can vary depending on the core services and business model of your firm, but they typically revolve around areas such as sales, client satisfaction and retention, employee productivity, and financial performance.

KPIs serve as benchmarks against which progress can be measured. They help design firm owners track their performance over time and identify areas where improvements can be made. By setting specific targets and monitoring relevant metrics, owners can gain a clearer understanding of their firm’s strengths and weaknesses.

For example, let’s say a design firm wants to increase its client base. One of their KPIs could be the number of new clients acquired within a given period. By regularly tracking this metric, the firm can assess whether their marketing efforts are effective in attracting new customers. If the number falls below expectations, it may indicate a need to adjust their strategies or invest more resources in lead generation activities.

Another common KPI for design firms is project profitability. This indicator measures the financial success of individual projects by comparing the revenue generated against the associated costs. It helps owners identify which projects are most profitable and allows them to allocate resources accordingly.

Some firm owners also track average customer acquisition cost so they can compare how much it costs to sign a new client with how much they make off of that client. Many firm owners segment clients into different categories and assess the cost vs profit margin ratio of customers acquired in each segment.

Key Financial Metrics Every Interior Design Firm Owner Should Know and Track

Revenue

Revenue refers to all the money that a firm generates from its operations. It is the total amount of cash brought in by selling goods or services. Revenue is basically income.

When we talk about revenue, we are talking about the money that flows into a business as a result of its primary activities. This can include sales of products, fees for services rendered, or any other form of income that your design firm receives.

Profit

Next, let’s look at profit. Profit is the difference between the revenue generated and the expenses incurred by your design firm. When a firm earns more money than it spends on operating costs, it generates a profit. This surplus can be reinvested into your firm for growth and expansion, distributed among shareholders as dividends if you have sold equity, or used to pay off debts.

There are different types of profit that businesses track to assess their financial performance. These include gross profit, operating profit, and net profit. It’s important to note that firm owners describe profit either as a dollar amount or a percentage. When described as a dollar amount, we say “profit.” But when described as a percentage, we say “profit margin.”

Gross Profit Margin

Gross profit margin is a crucial financial metric that helps businesses understand their profitability. It measures the percentage of revenue left after deducting the cost of goods sold (COGS). In simpler terms, it shows how much money a company makes from its core operations.

To calculate gross profit margin, you need to subtract the COGS from the total revenue and then divide the result by the total revenue. Gross Profit Margin = (Total Revenue – COGS) / Total Revenue.

Operating Profit Margin

Operating profit measures the amount of profit generated from regular business activities, excluding any income or expenses that are not directly related to those operations. While gross profit measures the difference between revenue and the direct costs associated with producing goods or services, operating profit includes additional expenses such as overheads and administrative costs.

To understand operating profit better, let’s break it down. The term “operating” refers to the day-to-day activities involved in running a business, such as manufacturing products, providing services, and selling goods. These activities generate revenue and incur costs, resulting in either a profit or a loss.

Operating profit specifically focuses on the difference between the revenue earned from these core operations and the expenses incurred to carry them out. It excludes non-operating items like interest income, interest expense, taxes, and one-time gains or losses. By doing so, operating profit allows you to assess how well your firm is performing based solely on its primary business activities.

Net Profit Margin

Last but not least, net profit refers to how much cash is left over after deducting all expenses from the total revenue your firm generated during a certain period. Net profit is often expressed as a percentage of revenue — known as the net profit margin.

Remind Me: What’s the Difference Between Profit and Revenue?

Profit and revenue are two important financial concepts that often get confused with each other. While both terms are related to a company’s income, they have distinct meanings and implications. Revenue represents the top line of a company’s financial statement, profit reflects the bottom line.

Revenue refers to the total amount of money a company generates from its operations. It represents the inflow of funds into the business resulting from the sale of products or services. Revenue is essentially the top line on a company’s income statement and serves as a measure of a company’s sales performance. For example, if a design firm makes a total of $40,000 off furniture sales across all clients in a single month, their revenue for that period would be $40,000. In this example, we are referring to what the firm owner made off of their markup – not the sale price of the furniture. 

Profit is what remains after subtracting all expenses from revenue. It is the bottom line on an income statement and indicates how much money a company has left over after covering all costs associated with producing and selling its products or services. Profit is a key performance indicator of a company’s financial health and sustainability. 

There are different types of profits such as gross profit, operating profit, and net profit. Gross profit is calculated by deducting only the cost of goods sold (COGS) from revenue while operating profit includes all operating expenses. Net profit takes into account not only operating expenses but also non-operating expenses like taxes and interest.

To illustrate the difference between revenue and profit, let’s go back to our furniture example. If the furniture incurs $12,000 in costs including hours spent on procurement and other expenses, their profit for the month would be $28,000 ($40,000 – $12,000). In this case, the firm generated $40,000 in revenue but made a profit of $28,000 due to the various expenses involved in obtaining and delivering that furniture.

Look Closely at Profit – Not Just Revenue

Revenue represents the total income a company earns from its operations, while profit refers to the amount of money left after deducting all expenses from revenue. While revenue is an important metric for assessing sales performance, profit provides a clearer picture of a company’s financial success and sustainability. Understanding these distinctions can help individuals make informed decisions when analyzing a business’s financial statements or evaluating investment opportunities.

A design firm might have high revenue numbers, but if its expenses are equally high or even higher, then it might not be profitable in the long run. On the other hand, a company with lower revenue numbers but efficient cost management may still be able to generate healthy profits.

Investors and stakeholders often look at a company’s profit figures as they assess its financial viability. Profitability is crucial because it indicates the company’s ability to not only cover expenses but also have money left over for growth, expansion, and future investments. A design firm that consistently generates profits demonstrates its capacity to survive in the market and potentially increase its value over time.

Monthly Burn Rate

Monthly burn rate refers to the amount of money a firm spends each month in order to sustain its operations. It is an important metric that helps small businesses understand their financial health and make informed decisions about budgeting and resource allocation.

This metric tracks how fast money is “burned” or used up by your firm each month. Just like a candle burns down over time, a company’s funds gradually decrease as expenses are incurred. You will probably monitor your firm’s gross burn rate, which this resource from CFI defines as total operating costs.

Understanding your monthly burn rate is crucial for several reasons. Firstly, it allows you to assess whether your current revenue streams are sufficient to cover your expenses. If your burn rate exceeds your income, it means you’re losing money every month and need to take action to either increase revenue or reduce costs.

Additionally, monitoring your monthly burn rate enables you to plan ahead and make adjustments if necessary. By knowing how much money you’re spending each month, you can better forecast future cash flow and determine when additional funding may be needed.

Calculating the monthly burn rate involves adding up all the fixed and variable costs associated with running your business. Fixed costs include things like rent, salaries, utilities, and insurance, while variable costs encompass items such as marketing expenses, raw materials, and inventory.

Once you have determined your total monthly expenses, divide that figure by the number of months in a year to get your average monthly burn rate. This brings us to fixed versus variable costs.

Fixed Costs vs Variable Costs

Fixed costs are expenses that remain constant regardless of the level of production or sales volume. They are the expenses that a business incurs even if there is no output or activity taking place. Examples of fixed costs include rent, insurance premiums, salaries of permanent employees, and lease payments.

Think of fixed costs as those bills that need to be paid regularly, regardless of whether your business is booming or experiencing a slow period. They are stable and predictable.

On the other hand, variable costs are directly related to service and product sales. As the name suggests, these costs vary depending on the amount of output generated by your business. Variable costs increase when sales or production activity increases. They decrease when that activity decreases. Variable costs can include raw materials, wages paid to independent contractors, packaging supplies, and commissions.

Top Line Items vs Bottom Line Items

Top line items include all the revenue generated by a business, such as sales of products or services. This is the total amount of money coming into the company before any expenses or costs are deducted. It represents the overall growth and success of a design firm in terms of generating income.

The bottom line is calculated by subtracting these expenses from the revenue generated. In simple terms, it represents the net profit or loss made by your firm after deducting all costs. Net income is another term for your firm’s bottom line.

Both top-line items and bottom-line items are crucial financial KPIs for the average small business owner. While top-line items provide an overview of revenue growth, bottom-line items reveal how efficiently a business manages its expenses. By analyzing both figures together, investors and stakeholders can gain a comprehensive understanding of how well a company is doing financially.

As briefly outlined above, focusing solely on top-line items can be misleading. It’s important to analyze both figures together to gain a complete understanding of your business’s performance and make informed business decisions.

Break-Even Point

The break-even point is the point at which a firm’s total revenue equals its total costs, resulting in neither profit nor loss. In simpler terms, it is the moment when a business starts to make money after covering all its expenses.

Net Worth

A business’s net worth is a measure of its financial standing and value in the market. Net worth compares debt vs equity. Basically, it is the difference between how much your business owns and owes. Net worth is calculated by subtracting total current liabilities from total current assets.

We explain how to calculate your firm’s debt-to-equity ratio, debt-to-income ratio, and debt service coverage ratio in our Summer Finance Series. Sign up for the second workshop in our series — all about using debt to generate revenue for your firm — here.

Operating Costs

These costs are the expenses that your firm incurs on a regular basis to keep its operations running smoothly. These costs can include everything from rent and utilities to employee salaries and office supplies.

Operating costs refer to the day-to-day expenses that a company must pay in order to stay operational. They are different from one-time or occasional expenses, such as purchasing new equipment or renovating an office space. Operating costs are ongoing and recurring, making them an essential consideration for any business owner or manager.

One common type of operating cost is rent. Whether you lease studio space, a retail storefront, or a receiving warehouse, there is usually a monthly rental fee associated with it.

Utilities also fall under the category of operating costs. Without these essential services, most businesses would struggle to function efficiently. Paying utility bills regularly is therefore vital to ensure uninterrupted operations.

Another operating cost is employee salaries and benefits. Every business relies on its workforce to carry out daily tasks and provide valuable services to customers. As such, paying employees their wages and providing benefits like healthcare coverage or retirement plans is a necessary expense for any business.

Cash Flow

We are always talking about cash flow in the DesignDash Community! Cash flow refers to the movement of money into and out of your firm over a specific period of time. It encompasses both the inflow of revenue from sales and services rendered, as well as the outflow of expenses such as rent, salaries, and supplies.

Understanding how much cash flows through your business is essential for managing day-to-day operations, ensuring that you have enough funds on hand to cover immediate expenses and invest in future growth opportunities. By tracking your cash flow closely, you can identify potential cash shortages and take proactive measures to address them, whether by adjusting spending, securing additional financing, or exploring new revenue streams.

Operating Cash Flow

Last on our list of key financial metrics is operating cash flow, which represents the cash inflows and outflows directly related to a firm’s primary operations. This includes revenue from sales, payments for raw materials or inventory, wages and salaries, rent, utilities, and other expenses necessary to keep the business running smoothly.

A positive operating cash flow indicates that a company is generating more cash than it is spending on its operations. This is generally seen as a good sign because it means the company has sufficient funds to meet its obligations and potentially reinvest in the business. On the other hand, negative operating cash flow suggests that a company may be struggling to generate enough cash to sustain its operations.

It’s worth noting that operating cash flow does not take into account non-operational items such as interest income or expenses, taxes, and one-time gains or losses. These are excluded because they are not directly related to a company’s core operations.

Final Thoughts on Business Financial Metrics Each Firm Owner Must Know

The metrics defined in this post help firm owners understand their financial obligations and opportunities. Keep an eye on each of the financial metrics listed above to track performance, identify cost overruns, and determine the right time to pursue an expansion. Curious about other metrics and KPIs? Ask questions in the comments below, or join our DesignDash Community to chat with mentors and peers here.