Measuring Project Profitability for Professional Services
In project management, determining the potential profitability of an initiative is very important. Profitability analysis in project management is how businesses can decide whether or not a project is worth the time, effort, and resources that will be allocated towards it. It’s also how businesses can decide to prioritize one project over another when there are multiple projects that may be competing for resources within an organization.
What is project profitability?
Project profitability describes the ability of a project to yield a financial profit or gain for an organization. In an effort to grow quickly, some firms may take on projects with slim profit margins, which can impact the overall financial health of the business. Other firms may mistakenly believe that a high dollar initiative is the same as a profitable initiative — it is not.
Scope creep, low employee utilization, and other factors can impact the profitability of such a project. The Project Management Institute also points out that "risk associated with different contract types affects the profit expectation.”
How to measure profitability
How can professional services organizations forecast, measure, and increase the profitability of the projects they take on? Visibility is key on all fronts. Having a top-down view of resources, time spent, and utilization rates help businesses take a long lens approach to assessing project profitability.
Businesses can use tools like the profitability index (PI) to determine the potential profitability of a project. Analyzing profit margins can also help businesses track revenue and overall financial health.
Taking on new projects and investments is crucial to the growth of any business, but making sure these initiatives are profitable is just as important. So, how do businesses decide how to make one investment over another? They often use a tool called the project profitability index (PI).
The profitability index (also known as the cost-benefit ratio or profit investment ratio) helps businesses determine the potential value or profitability of a project. Growing professional services organizations often have limited capital, so this index can help reveal viable investment opportunities. For instance, if there are multiple investments being weighed by an organization, the firm may use the profitability index to rank the projects according to whether the expected revenue is higher than its initial investment (ROI).
What is a good profitability index and what is the project profitability index formula?
Profitability index = Present value of future cash flows/initial project investment.
This index represents the amount of money that is earned for every dollar invested. If the index is higher than 1, the project is likely viable.
- If the index is less than 1:
This means the project is not viable. Your business will invest more than they will take out of this initiative and the project should not be pursued.
- If the index is equal to 1:
This means the project will likely break even. While not a loss, businesses rarely make investments for the purpose of breaking even. This project should also be avoided.
- If the index is greater than 1:
If the index is greater than 1, the project should be pursued because it is likely to be profitable.
Understanding Profit Margins for Project Management
In project management, analyzing profit margins can help companies understand a lot about their business — including how profitable their work actually is. It’s easy to take project revenue as the ultimate benchmark. However, analyzing profit margins paints a more comprehensive picture of growth, revenue, and overhead costs in order to truly understand profitability.
Firms need to bring in more money than they put into a project in order to improve their bottom line, rather than just covering project costs. Understanding profit margins can also help businesses rank and decide internally on the projects and clients worth continuing with.
Gross profit margin and net profit margin are typically expressed in percentages but paint slightly different pictures about revenue.
- Gross profit margin
Gross profit margin tells a company their profit after deducting expenses from the project revenue. The gross profit margin does not generally take into account things like tax, interest, and other admin costs
(Project revenue - project expenses/project revenue x 100)
In professional services, firms generally aren’t selling manufactured goods. Instead, they are offering their expertise.
For example, an event planning company may charge a flat fee of $28,000 to plan a tech conference on behalf of an organization. If the event company’s expenses total $19,000, they have made a profit of $9,000, which is a 32% gross profit margin (9,000/28,000 x 100).
- Net profit margin
As Investopedia states, “net profit margin is equal to how much net income is generated as a percentage of revenue.” It not only factors in total revenue, but other operating and overhead costs.
(Revenue - Expenses, taxes, operating costs, other expenses)/revenue x 100
What is a good profit margin?
According to Inc, “most professional service firms have operating profit margins from 25-40%”, which means 25 to 40 cents of every dollar earned goes to the bottom line. Companies with fewer overhead costs tend to have better profit margins than companies who have higher operating costs. This is because more money goes toward the bottom line, not just covering operating expenses for the business.
One 2016 report identified bookkeeping, accounting, tax preparation, payroll, and legal services as the industries with the highest profit margins.
Increasing profit margins
In professional services, increasing profit margins isn’t just about raising the cost of your services. Improving productivity and project efficiency play a huge part, as well. Here are some of the ways becoming more efficient can increase your company’s profit margins.
- Eliminate scope creep
Poorly defined project scope can lead to missed deadlines and budget overrun. This, in turn, can increase project expenses and impact its profitability.
32.2% of respondents in one survey said clients changing their mind was their biggest barrier to productivity. Defining project scope early on can mitigate this productivity black hole.
- Cut clients and projects that take up resources but have low profit margins
Some clients and projects simply aren’t worth the time, effort, and resources put into them. Identify projects with razor thin or non-existent profit margins and prioritize more profitable initiatives.
- Use time tracking software to measure employee utilization
High employee utilization rates mean that workers are spending a greater proportion of their available working hours doing client work. More client work means more billable hours, which means higher profits. Track and respond strategically to this important metric.
- Make client retention a business priority
It costs five times more to bring in a new client than to retain one. So, what does that mean? Your business should make client retention top of their list of priorities.
Project Time Tracking
What is project time tracking?
In project management, time tracking is useful for resource management and for measuring the length of time spent on a specific task or series of tasks. Project time tracking is also crucial for teams who bill clients based on an hourly rate, such as consultants.
According to research, 15% of billable activities often go unreported. This means that businesses are losing out on money simply because they are not more organized in tracking their billable work. Project management tools with time tracking capabilities help teams log and manage the hours spent doing work on behalf of clients.
Let’s say, for instance, that a marketing consultant, Sam, is hired by your organization. At $85/hour, Sam completes the following tasks:
- Creating a new brand guide
- Developing an SEO plan
- Developing a content plan and calendar
- Planning and commissioning a new logo
Sam logs each of these tasks and their duration within Wrike by selecting the time tracking option. In total, Sam has completed 11.5 hours of work for this project and logged all these hours within Wrike. Based on their rate of $85 and an hourly structure, they can bill your organization for $977.50.
Logging these hours within Wrike ensures that there is a record for both the client and consultant to reference. Accurate time tracking can also make businesses more profitable because it ensures that all the eligible work that has been completed is accounted for — meaning that there is no money lost because of inaccurate time estimates.
A project management tool with time tracking features can also track productivity. Time tracking isn’t just about making sure teams get paid for all the work they do. It can also be useful for revealing bloated and time-consuming processes.
If you think about it, you can probably identify one task in your daily workflow that is inefficient and begging to be templatized or automated. If it’s not immediately obvious, a time tracking tool might reveal such a task in your process.
Using project time tracking software to log both billable and non-billable work can give managers a sense of how much time workers spend on productive vs. unproductive tasks. Learn more in the full Project Time Tracking section.
Employee Utilization Rates
Employee productivity is at the heart of profitability. This means that the daily work an employee does should, in theory, drive revenue as much as possible. One important metric in measuring productivity is employee utilization. Employee utilization is normally expressed as a percentage and tells us how much of an employee’s available time was spent doing billable client work.
The higher the percentage, the more time has been spent doing work that can be billed to a client. A utilization rate of 100% is unlikely, and is not necessarily a good thing. It means that an employee spends all their available hours doing client work. As Productive.io points out, a 100% utilization rate also means that non-billable, yet important, activities like team-building within a business are being neglected. This can be bad for employee morale and lead to employee burnout and eventually, turnover.
Employee utilization rate also helps to paint a picture of the overall productivity of an organization. For example, if employee utilization rates are close to 100% across the board, it may be time to hire more employees in order to avoid burnout. On the other hand, if employee utilization rates are low, there may not be enough client work.
How to calculate utilization rate
The employee utilization formula is simple. The formula is: Employee utilization = billable hours/total hours in a work period x 100. You can easily calculate the utilization rate for an employee within a 40 hour work week by using the time tracking feature in Wrike.
If an employee logs 29 hours a week (out of a possible 40) doing billable client work, their utilization rate for the week is 72.5%. Without a time tracking system in place, calculating employee utilization is nearly impossible. Calculating employee utilization can only be done with strong insights into what employees are working on and when.
For professional services organizations, measuring, monitoring, and optimizing profitability are vital for growth. When it comes to tracking time and productivity, businesses need robust and versatile software like Wrike. Wrike features help teams track time spent on client work and can provide crucial insights that aid in strategic decision-making for increased profits.