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Understanding Business Processes for MSPs: Finance and Profitability

Understanding Business Processes for MSPs: Finance and Profitability

The typical MSP doesn't have an MBA or a background in business management. Yet running a successful MSP operation nonetheless requires careful management of the financial aspects of the business.

With that need in mind, this article provides an overview of the essential things to know about managing finances for an MSP business. It explains which types of financial data to track, which software tools to use and how to calculate and improve overall profitability.

Financial KPIs Every MSP Should Track

Keeping track of financial key performance indicators, or KPIs is a basic first step in managing the financial aspects of your business effectively. Financial KPIs provide the data you need in order to understand how your business is performing financially and find ways to improve your financial results.

Although the exact KPIs tracked by MSPs vary from business to business, the following are the primary KPIs that you should consider collecting:

  • Revenue: This is a measure of the total income generated by your business. By tracking metrics such as recurring revenue (meaning the revenue you generate on a recurring basis) and source revenue (the revenue generated by a specific client), you gain a high-level understanding of how your business is performing financially on an ongoing basis.
  • Margin: Your margin refers to the profit you earn. It is calculated by subtracting your operating expenses from your revenue.
  • Cost of goods and services sold: This metric, called COGS for short, reflects the direct expenses you incur from providing services or products.
  • Effective rate per customer: This KPI, which represents your earnings from a specific customer, helps you identify which customers are delivering the most value to your business.
  • Effective rate per offering: This metric tracks how much you earn on different types of services or products, and helps you identify the most profitable ones.
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For tips on additional KPIs you can consider tracking, as well as how to assess the effectiveness of a given KPI for your business, check out our article on financial KPIs for MSPs.

Further reading Introduction to Financial KPIs for MSPs

Calculating MSP Profit Margins

We mentioned profit margins above but, because calculating profit margins is more difficult than it may seem, let's discuss them in more detail.

A profit margin is a measure of how much money your business is making. It represents which portion of your overall revenue (meaning the total income you generate) turns into profits after you have accounted for all of the expenses (such as employee salaries and the cost of materials) required to perform the duties you promise when you make a sale.

There are different approaches you can take to calculating profit margin. The most common method is accrual-based accounting, which means that revenue is recorded at the time it is invoiced, not when the customer pays (which could be several months after the invoice). Depending on which method you use, your revenue for a given period of time may vary, even if your sales are the same.

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However, as long as you are consistent in the accounting method you use, your profit margins will allow you to compare business performance accurately over time.

What Is a Good Profit Margin?

Service Leadership INDEX research indicates that the average profit margin for MSPs is 8 percent, while “best in class” MSPs have margins of 18 percent.

That said, in some cases, your profit margin may be lower, and that may be OK. If you are in a period of growth and are reinvesting earnings in your business, your profit margin may be minimal or even negative. As long as there is a good business reason behind the margin, this is not a bad thing.

Further reading Introduction to MSP Profit Margins

Software Stack for MSP Finance and Accounting Management

Just as you rely on software to help power your MSP operations, finding the right software tools to help manage your finances is critical to operating efficiently.

There are two main types of finance software for MSPs to use: a PSA platform and accounting tools.

A PSA platform is essentially an operating system for your MSP business. The key features of PSA systems include:

  • Project management: These features help you meet client project milestones and manage project schedules.
  • Resource management: Helps to match available technicians to appropriate projects, which improves resource utilization.
  • Time and expense management: Allows you to keep track of employee time, and the resulting expenses, for billing purposes.

Thus, using a PSA tool, you can track the money you receive from a particular client, how much money was transferred to your account from a given client, and so on.

Popular PSA options that are frequently used by MSPs include Connectwise, Autotask, Atera, and Accelo.

In addition to PSA platforms, MSPs also commonly use accounting software for tasks such as invoicing customers, paying bills, tracking cash flows, generating month- and year-end financial reports and filing taxes.

Whereas a PSA lets you track money within the framework of your various projects, accounting platforms provide a higher-level overview of all of your business’s financial data.

The most popular accounting software platforms for small businesses include Quickbooks, Xero, FreshBooks, and Wave.

Working with an Outsourced Bookkeeper

If maintaining your own accounts seems daunting, keep in mind that outsourcing the work to a contract-based bookkeeper is an option. You could work with an outsourced bookkeeper on a permanent basis, or hire one to consult with you on a one-time basis to help you get your accounting operation in order.

For more tips on financial software for MSPs, see our article, "Software Stack for MSP Finance and Accounting Management”.

Further reading Software Stack for MSP Finance and Accounting Management

Conclusion

Managing the financial aspects of an MSP business is hard work. But it's necessary if you want your business to grow and remain profitable over the long term. Fortunately, with the right tools and strategies in place, tracking and reacting to financial data is easy to do in an efficient way.

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