Can You Pass the “Acid Test?”

One of the many good news / bad news facts of life for interior designers is that there are many different ways to earn a great living. (And many ways to earn a crappy living, too.)

The good news is that design firm principals can craft a business model that they enjoy operating, and make it work. A common range of options takes into account how much merchandise is sold versus how much time is billed. I’ve seen firms generate nice net incomes selling almost no merchandise, and billing almost no time but, of course, not both!

The bad news is that unlike, say, a car dealership, there is not just one way that can be analyzed, documented and taught to all the other car dealerships.

I can lead your horse to water, but he may not want to drink!

With that long caveat, let me give you one series of benchmark ratios, what I call the “Acid Test,” that you can conduct in about five minutes. It is a measure of an interior design firm, large or small, that is operating efficiently and generating earnings for the principal that are within the top quartile of all such firms.

The Acid Test is this: 30/30/7, and here’s how to quickly calculate it.

  • Generate a P&L statement for the past 12-24 months. Calculate your gross profit margin solely on merchandise sales.
    • That’s the amount your customer paid you, less the cost of those goods (COGS), divided by the amount your customer paid you.
      • Example:
        • Merchandise sales of $565,000
        • Cost of goods sold of $367,250
        • Difference of $197,750
          • Gross profit of $197,740 divided by total sales of $565,000 = 35%
  • The goal of the first measure, or “30,” is to have a gross profit on merchandise sales that is at least 30%. The designer in this case exceeded that standard.
  • From that same P&L statement, find the sub total for “total expenses.” This should include all wages including yours and everyone else who bills time, even hourly workers. (Do not include these labor costs in “costs of good sold!”)
    • Divide this number by total sales. (Total sales will be higher than “Merchandise Sales” since it will also include all time billings.
      • Example
        • Total Sales of $764,000 (The $565,000 in merchandise shown above plus $199,000 for time billings.)
        • Total Expenses of $206,280
          • Total Expenses to Total Sales equals $206,280 divided by $764,000 or 27%
  • The goal of the second measure, or the second “30,” is that total expenses, including all billable labor, should be less than 30%. Here, we have a solid number of 27%.
The last measure, or “7,” simply says that the owner of this firm should draw a salary of at least 7% of total gross sales, or in this case:
  • $764,000 x 7% = $53,480.

How to Increase Your Income—Three Ways

You may want to argue that you should earn more than that, but what these ratios are telling you is that this is what a firm of this size, and of this operating efficiency, can support. There are only three ways to earn more without increasing sales and staffing, and they will each have limits on what is realistic.
  • Increase your margin on merchandise sales
  • Raise your billing rates
  • Reduce overhead expenses
I prefer that Edge members pay themselves 10% of gross sales, and bring another 7-10% to the bottom line for a 20% ODI, or “owner’s discretionary income, which means we’d have to tweak one or more of these three variables.
Remember, there are countless different ways to generate a great bottom line, and like all averages, this one will be spot-on for almost no one. But the most important aspect of analytical tools is not to provide answers, but to provoke questions, and the 30/30/7 “Acid Test” is quick and valuable for that.
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