Sometimes the day to day demands of running a professional services business can be overwhelming, especially for creative and technical entrepreneurs and project managers that do not have a financial background. Trying to stay on top of administrative responsibilities, hiring and managing staff, and keeping clients happy can make it difficult to really understand how the firm is performing. Many leaders also struggle to understand and analyze reports and financial statements, and determine where to focus their attention to ensure success.
While there are many important metrics and reports that you can look at each month to gauge your company’s health and profitability, you can get a pretty good understanding of the performance of the business by looking at just four metrics – the Win Rate, Utilization Rate, Project Profit Margin, and the Average Collection Period (or Days Sales Outstanding). By looking at just these four key performance indicators, you can simplify the process of analyzing how projects are being executed and managed, and help your project managers and leaders focus their attention where it will get the most benefit
The Win Rate is calculated by dividing the number of projects won during the year by the number of proposals submitted. This is the measure of the success of your marketing, business development and proposal efforts. Four components ultimately affect win rate – lead generation, Go/No-Go process, sales process, and proposal development. In order to increase the win rate, you must go after more and better leads, effectively manage the process of capturing opportunities, have a solid process for deciding which projects to go after, and develop high quality, targeted proposals. By analyzing the win rate you can assess the effectiveness of your marketing and proposal efforts, and make changes to increase the success of your front-end processes.
The Utilization Rate is calculated by dividing your billable employee direct (project) hours by the total standard hours in the period. For a year this is normally 2,080. Some firms use other formulas to measure utilization; any way that you choose to measure it is fine as long as you are consistent. This metric shows you how well you are managing your most valuable resources – your people. It must be looked at along with the Project Profit Margin as the two must be balanced against each other for a true understanding of how the company is doing. Utilization measures the percentage of time that your billable employees are working directly on project as opposed to overhead activities. If billable employees are not working on projects, the overhead rate will increase, and project profitability will decline. Looking at utilization alone is not effective as employees may also spend too many hours working on projects, and drive project profitability down. Forecasting project backlog and opportunity pipeline can help to determine future staffing requirements, and ensure that adjustments and hiring decisions are made at the right time which will have a positive impact on the utilization rate. Analyzing your utilization rate along with the Project Profit Margin can give a clear picture of both your resource management and project management success.
Project Profit Margin
The project profit margin is calculated by dividing project profitability by the total amount spent on the project, including an allocation for overhead. It is usually calculated for each project and department in the firm, as well as the overall profit margin for the entire company. The project profit margin is one of the most significant of the financial metrics for a professional services firm. It shows how well the firm is managing people, controlling project costs, and controlling overhead. By looking at project profitability in a number of ways, such as by project manager, office, and type of work or client, you can start to do the type of analysis needed to understand the intricacies of the business, and make adjustments where needed. It is also valuable to look at profitability trends over time to determine if there are certain times of the year where the business does better or worse. By setting profit goals for projects and managers, and monitoring them on a monthly basis, you can stay on top of problems before they become losses. Along with the utilization rate, the project profit margin is a vital indicator of how the firm and specific units, managers, and offices are performing.
Average Collection Period
The average collection period is calculated by dividing the total average Accounts Receivable (AR) by the gross revenue per day (gross revenue/365). The longer the average collection period, the more the company has to borrow to cover the cash requirements of the firm. The Average collection period is a critical indictor of the health of the firm from a cash flow standpoint. Since most firms are managed on an accrual basis, just looking at billing alone each month can be deceiving. Implementing effective time management, invoicing, and collections processes will make a huge difference in reducing the average collection period, and ensuring the firm’s cash flow health.
While there are many metrics that you can use to understand how your firm is performing, I have provided a simplified approach to measuring and monitoring your financial health. Most firms have managers and principals that do not understand accounting and finance, and may be intimidated by detailed financial statements and reports. By giving them a few key performance indicators to stay on top of each month, you can more easily hold them accountable, and give them an easier way to stay on top of their areas of control.