In this article, we're going to look at project profitability. Even though it's one of the key metrics, we're still surprised to hear that so many project managers or Chief Operating Officers don't measure the profitability of their projects.
Why is project profitability important?
Basically, looking at project profitability metrics allows you to:
1. Know everything about your projects
You get to see how much money you're making per project. And in case of fixed fee projects, for example, whether you're making any money at all. Sometimes, you may have underestimated the project and not make any profit whatsoever,
actually losing money!
2. Know who your ideal client is
In sales or marketing, you will very often be asked what your ideal clients are. And project profitability is one metric that helps you answer that question so you can compare projects and clients between themselves and see where the profitability is the highest, meaning where it's good for you to focus your efforts or what types of clients to look for in the future.
How to measure project profitability?
We put together a simple spreadsheet you can use to measure the profitability of your projects.
Click here to view and download the spreadsheet
Let's have a look at it. The first thing you will probably notice is that we have a timeline for the year, going from January until December 2020. And we've got the first project there as well - it will serve as our example.
Let's look at the individual rows. The first one is for billable hours. So what we can do here is export the total number of billable hours work by our team on the project in a given month. When we export that from our time tracking software, we can also make a note of the non-billable hours. For example, in our case, these would be the hours spent on things like account management or administration around the project.
The next row is revenue. Getting to this number is actually quite complicated because of many manual steps. So first, we need to know who worked on the project. Then we need to look at these individual team members, have their billable hours and billable rates, and then multiply them.
So, for example, developer A worked two hundred hours at a rate of 80 dollars per hour. We multiply that to get the total amount. We would have to repeat this procedure for everyone within the team. It's the number of billable hours in a given month times their billable rate (which may differ between team members). And that gives us the total number that we should bill the client for. We're ready to issue an invoice!
Obviously, it's smart to also confirm the timesheets at this point. Once we've got our invoice, we get the number that basically states our revenue.
But in this example, we need to exchange it for one common currency for clarity. In our case, it's Polish zloty, but you may use US dollars, British pounds, euros, or any other currency. That's our revenue based on the actual invoice amount.
Cost of labor
Then we need to calculate the cost of labor. So let's follow a similar procedure, meaning that we look at individual team members and the number of hours they've spent on the project in a given month. Instead of a billable rate, we use the cost rate - a rate that indicates how much we need to pay our specialists.
So we take a salary and divide it by the number of work hours in a given month to get the average hourly cost of a specialist. And then, we multiply the number of hours by this cost rate to get something that we call the cost of labor.
Once we have the revenue and cost of labor in place, we're finally ready to calculate the gross profit.
How to do this? Just by subtracting the cost of labor from revenue. Now we know how much money we've made as to the gross profit on the project in a given month.
Note that gross profit isn't the final metric. We're just taking into account the billable rates and the cost rates, nothing else. So that's like the very first profit we look at - but it's still a very meaningful metric. It might be enough for the purpose of operations, for example.
If we wanted to look at more detailed financials, we would have to create a more comprehensive document that includes all the other costs, such as overhead, marketing, office management, etc. But that's more important to the Chief Financial Officer or an accountant.
So we've got the gross profit that we make on the project. The margin is nothing else - it's the profit expressed in percentages.
What's interesting is that we can calculate many more interesting metrics here:
- Average hourly rate - to get to this metric, I take the revenue and divide it by the total number of hours spent on the project (both billable and non-billable) to learn the real value of the hourly rate in a given month.
- Annual totals - this metric indicates our performance from the beginning of the year up to this point, as well as some averages. So it helps us to compare one project to another - for example, how much profit we've made on this one versus another one, what the margin looks like.
We can follow these steps every month once the previous month ends. We probably need to wait 5 to 7/10 days until all the timesheets are accepted and signed off. So actually a bit of time passes before we can see what our performance was like in the past month.
The tediousness and time involved in this process were one of our pains - and hence the idea of Weekly. We're now building a solution that will give us these numbers automatically.
You can only imagine the benefits of this. First, we won't have to rewrite all of this information from many various sources, such as time tracking tools or some other Excel spreadsheets. Second, all of these calculations will be done automatically. The multiplication of billable or cost rates, times the number of hours spent working on the project, times the number of work hours in a given month - it's all going to be calculated automatically.
These statistics will be available immediately, in real time. So you will no longer have to wait for our administrative assistant to help you or spend 5 to 10 days waiting until the timesheets are ready to be calculated. This data is going to be gathered on an ongoing basis and available to you at any given point.
This spreadsheet is a good starting point. But it gets messier when you've got a lot of projects and operate for a few years. That's another pain point we've experienced that pushed us towards Weekly.
Over to you
We hope that you found this article helpful. We've made this spreadsheet available for you to view and copy for your own purposes. If you'd like to start using that and are interested in getting something slightly more sophisticated, we encourage you to sign up for the waitlist. You'll get instantly notified when we launch our tool that will help you to automate and save time on tasks like this one.
If you'd like to summarize what you've just learned, check out our video with a step-by-step guide.