Episode 60: How to Measure Your Creative Practice’s Costs

Over the past few episodes we’ve been imagining what it might be like to present our creative practice on Shark Tank. The fundamental goal in soliciting investors is to establish and justify the valuation of your company. A fundamental factor in that judgment comes from the profit margins associated with your business. For creatives it can be quite difficult to calculate that, especially since the biggest cost center is your own time. And what’s that worth? In today’s episode we’ll consider how to calculate this critical part of the valuation equation—and some of the serious consequences that result from getting it wrong.

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Watching shows like Shark Tank is both entertaining and informative. They deliver important insights into what it takes to build a successful business. Another show I enjoy is Restaurant Impossible. When Robert Irvine first meets with a restaurant’s owners, he’ll often ask them about their numbers—how much are their food costs, what are their staffing costs, what’s their rent and overhead. When an owner is not able to answer these basic questions, he does not hold back on chastising them for so poorly operating their own businesses.

What if Robert were to show up to do an “Agency Impossible” episode with your practice? If he drilled you on your overhead, production costs, and salaries, would you be able to answer? That can be hard to do, because whereas a restaurant owner could tally up their receipts and invoices, and then add payroll, the main ingredient in a creative practice is time.

Therefore, coming up with an honest valuation of your company, or precisely calculating your margins can be quite fluid. You could improve your margins by simply lowering your overhead by taking less pay. But this is hardly objective. In order to be honest with ourselves we need to put a firm price into the compensation cost calculation, and then let that value stand as we calculate all the other liabilities against our revenues.

But what should that value be? What should you be paying yourself as a creative entrepreneur? Of course there is no absolute answer to this, and the actual value will scale from one part of the country, or world, to another. Although this critical number is variable, there’s still a market answer—one that’s less fluid than how we adjust our compensation based on the ups and downs of our revenue. As a base, you should be able to find out what someone with your skills would reasonably make doing the same kind of work for another employer. Now that will be a range too, but if you aren’t measuring your real profit margins against at least the high end of that range you’re seriously misrepresenting to yourself the value of your own company.

But in fact your target number should be quite a bit higher than the industry average. And that’s because of risk. Every business venture involves risk, and striking out on your own as a freelancer, or starting up a creative firm, most certainly involves risk. Not only is it fitting to pay yourself more for taking those risks, you need to bank more revenue simply to hedge against the real possibility that you might come up on the flip side of risk, and not be able to pay yourself at all for a period of time.

Another way of establishing a fair compensation number is to imagine the possibility of selling your business to someone else. If they were to buy it from you—such that they themselves would then need to fill your role, or hire someone else who could fill it—would the amount you’d been paying yourself seem attractive to them or to another creative—as a salary? Or would they quickly say “no thanks.”

To the extent that you don’t calculate your profit margins with a well-padded, and attractive industry salary in the miz—you’re in effect subsidizing your profitability with your own personal losses. This might be necessary when you’re just starting out, or if you hit a real hard downturn for a season—but don’t bake a subsidized salary, that lowers your real valuation, into your creative practice.

As creatives we tend to value creative opportunity over profitable projects. But when we do this we take immediate and serious hits to our bottom lines. In the coming weeks we’ll continue to subject our creative practices to the Shark Tank microscope to learn how to build a successful and profitable business.

So until next week: don’t let the business of creativity overwhelm your creative business.