October 1, 2019
By Harmony PSA's Steve Duckworth
In our first installment of this series designed to explain what it takes to better understand your business, we outlined how to determine how much money your business is actually making. In this second part, we hope to help you better understand your staffing costs.
For technology and professional services businesses, staffing is the biggest fixed-budget cost – up to 70% of a company’s overhead. It’s also one of the hardest costs to allocate consistently. The connection between a company’s revenue streams and employment spend are often complex to analyze, and even harder to optimize.
It should be easy. If you implement a time sheet system, you will have clarity over what people are doing, how much they are earning, and where the money is going, right?
Unfortunately, time sheet systems alone have several drawbacks when it comes to calculating the contribution each employee is making toward the overall profitability of the company:
Time sheet project and task codes don’t easily map to clear revenue streams. Of course, for simple cases they can map directly, but in the general case for technology companies, there are many points of indirection that confuse the picture.
Time sheet entry granularity is very hard to manage across the entire organization. You will find examples of people who book 10-minute slots and others who book to the same code all week – and everything in between.
Fixed-price work is tough to analyze. Of course, at the project level, once it’s complete, you can derive some idea of the overall costs against revenue, but that will only be at the project level – not the employee
If you book hours and charge in days (a very common arrangement) and must also deal with overtime hours, how do you systematically decide what costs and revenue numbers are attached to individual time booked?
And this assumes that your time sheet system reflects all your current rate information, including details of your support revenue. Most systems don’t get implemented in this manner.
So how do you know what’s really going on?
8 Questions to Help You Understand Profitability
If you want a crystal-clear view of what’s going on, you need to be able to answer “yes” to the following eight questions:
Do you model each support contract as a project (or task) and then ensure that the budget on that project is adjusted with each change to the services definition provided under that contract?
Do you adjust earnings rates on fixed-price projects based upon the earned value of the work on a continuous basis?
Do you enforce ticket-level time entry, managing the granularity down to measurable work elements?
Do you apply consistent employee cost rates that fully account for overhead cost recovery of non-time-based factors such as rent and rates, etc.?
Do you only use non-client-specific time entry codes on tasks when the costs are recovered by client-specific activities?
Do you include consistent product code mapping in your product and task definitions?
Do you apply consistent algorithms to day rate-based work to ensure the treatment of revenue and costs are accurate and not over- or under-reported?
Do you do all this in a single system that provides accurate analysis on demand?
If you’re missing any yesses, your analysis will be inaccurate, partial and require significant post-processing effort to achieve a picture you can reliably use to make decisions.
As employee costs represent most of your fixed costs, this data gap precludes you from …
… having an understanding about the relationship between spending and earnings, except at the highest overall level.
How can you manage – let alone optimize – performance without this knowledge?
Getting the Data You Need
The solution to this problem lies in two simple concepts:
Use consistent time measures: Every time entry must acquire a cost and an earning value, using consistent time measures. The real trick is that the earning value must allow for the overall performance of the project and be able to automatically re-baseline historical values when things go well, or then they go wrong.
Index against all relevant attributes: These values must be indexed against the employee, the project, the customer, the product area, and all relevant attributes of the list you wish to use to analyze your business.
Plus, if you operate in multiple currencies, you also need to handle conversions consistently, saving values in both transaction and company base currency using rates applicable at the time.
This level of understanding can only be achieved if you know everything about the commercial model of the contract and can consider any changes that affect the value earned from the work. Implementing this approach will deliver the holy grail of professional services-based businesses, a true contribution analysis by product area, customer and employee, always.
Do this, and for the first time you will really know who is earning the money and why.
Now you can optimize your business performance from a position of knowledge, not hearsay or gut feeling. This will also provide you with an argument to increase the fees of customers who don’t pay enough to cover the costs of the services they receive.
Next time, in our final piece of this series, we’ll show you how to put together the information gleaned from these first two pieces to help get to the bottom of your profitability.
In a career that began in offshore engineering, migrated into investment banking and ended up with the co-founding of a software company 10 years ago, Steve Duckworth, CEO of Harmony PSA, has devoted his career to developing solutions solving project, accounting and business process problems. Follow him on LinkedIn or @HarmonyPSA.
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