Why is improving financial performance such a problem?
Let’s start with answering one key question: why improving financial performance is so important (and so troublesome)?
"The cash is the blood in the company's bloodstream. Without it, the company simply dies; that’s why we want to know the exact places where companies tend to lose their money."
Jakub Domeracki, co-founder of Value Finance
Every IT or service company measures financial performance to some extent. Some only stick to the basis, while others wish to embrace all the financial indicators in the world. Still, even though the process is so widespread, it often includes numerous mistakes and mishaps.
Of course you may say that mistakes happen, and you probably won’t be far from the truth. However, in financial performance these mistakes can affect your company on its every level.
In this article, I teamed up with Value Finance experts and co-founders, Jakub Domeracki and Adam Zagała, to show you how exactly finance performance can affect your business - and how you can use it to your advantage. Thanks to these insights, you will get a glimpse of years of experience with dozens of other software development companies (and probably you will have a chance to improve yours, too!).
What effect can incorrect financial performance have on my business?
For example, incorrect financial performance can:
- distort the results of financial reports, causing incorrect conclusions to be drawn and incorrect decisions to be made,
- convince managers that their projects are profitable or have high profit margins, even when the operations simply lose money,
- deter the investors who tend to spot such mistakes before they make a decision,
- cause the budget to be burned by unknown operations,
- slow down your company’s growth because of lack of cash and, more importantly, lack of understanding which projects really are the driving force behind the entire business.
Sounds bad? It should.
That is why improving financial performance in your company should be so important - in short, it can help you avoid making or supporting incorrect decisions that hold your business back.
However, while it may sound strange, solving the problems with financial performance does not have to be a burden.
Common financial performance mistakes made by managers
Fortunately, we have a good news for you - in many cases, especially in the service sectors, financial performance can be improved by:
Incorrect time tracking
According to Value Finance experts, entrepreneurs often misuse the time tracking features they have at hand, whether they use Jira time tracking or some other tools. That’s because they often:
- pay for unspecified operations or underreported hours,
- fail to analyze the reports or historical data and draw conclusions from them,
- do not create benchmarks for particular actions and operations, so they do not know how much time does it take to complete them,
- do not know what particular specialists do,
- fail to convince their employees to track their hours properly.
"Once we helped a company that had hired a new employee for the marketing department. After thorough analysis of the tracked time, we have discovered that this person had been spending 70% of their time on sales and recruitment work. Meanwhile, the executives still thought that the person was working for marketing."
Adam Zagała, co-founder of Value Finance
What problems can be caused by incorrect time tracking?
These problems have particularly negative implications for Time and Material projects, in which customers pay for every hour of work. In these projects, incorrect or missing time tracking records can result in understated invoices and lower profit margin. In other words, by eliminating these problems, your business can make more money and reduce benches at the same time.
In Adam’s experience, many customers have also discovered that their employees had spent the majority of their time on internal projects instead on the commercial ones. This usually means that some projects are not controlled properly - and their finances also can be misleading.
How to fix the problems with time tracking and improve financial performance?
If any of the above problems apply to your company, you can:
- Verify the time tracking processes. Take a look at the instructions regarding time tracking and check whether your team is aware of them. For the time tracking to be accurate, these guidelines have to be followed by every person in the company.
- Analyze the number of hours tracked by particular employees and teams. Check if they match the number of hours in their contract and their overall responsibilities. This process will help you verify whether you have a problem with time tracking, and it will point to its possible source.
- Choose one person responsible for the quality of time tracking. They should be responsible for checking the hours and comparing them to plans, estimates and contracts.
- Show that time tracking matters. Some specialists do not pay attention to the time tracking because they do not realize it impacts the work of the management and the company as a whole. Explain why the process is necessary and important - a simple conversation often works wonders!
- Switching to an hourly rate with reluctant employees. We are not gonna lie - some employees simply refuse to track hours, even with the simplest processes at hand. While uncommon, these individuals should not be ignored. Instead, they should only be paid for the hours they have added to the system.
- Track non-billable time. To understand how the real utilization of your employees looks like, you need to keep track of both commercial (billable) projects and internal (non-billable) operations, including meetings, administration, and more.
These rules do not apply only to software companies - service-based businesses, such as marketing agencies and consulting companies can successfully use the advice, too.
Inefficient time management and chargeability
Inefficient time management in a service or IT company usually refers to the large number of non-billable hours or dozens of hours spent on internal work. They are the root of low chargeability - a share of project hours in the overall capacity of the entire company.
In general, we consider time management inefficient when less than 50% of all the available hours in the company are spent on commercial projects. However, the chargeability rates differ across the company. For example, according to Value Finance’s calculations, good chargeability of the entire business should be between 70 and 80%. On the other hand, the chargeability for the development team should be around 90%.
"The record for the lowest chargeability I have ever encountered was around 45%. The owner of the company came to us and said that he had an excellent team, good market rates and dozens of projects, and yet he was losing money. It turned out that the chargeability was his problem all along."
Adam Zagała, co-founder of Value Finance
What are the consequences of low chargeability?
The incorrect chargeability has two main consequences:
- the wages in the company are too high compared to the workload,
- the employees could do more billable work for the same wage.
But how does it work in real life?
"Imagine a production team that has a budget of 500 thousand euros per month. If the chargeability of this team is 80%, it means that 400 thousand euros contributes to the project, and 100 thousand euros - to other endeavors. Now imagine that chargeability drops to 70%. Then, the non-project costs rise to 150 thousand euros. Therefore, 1% drop in chargeability corresponds to 5 thousand euro loss per month, and 60 thousand euros per year. That’s how inefficient time management makes you lose money."
Adam Zagała, co-founder of Value Finance
What can we do to fix problems with chargeability?
If you do not measure something, you cannot control it. Then, the right thing to do in that case is to start measuring chargeability and monitoring the financial performance it contributes to. Then, you will have a more precise idea of what the problem is caused by in the first place.
After that, depending on the results of your investigations, you can make a few critical decisions that can improve both your company’s chargeability and financial performance. These things include:
- limiting the amount of internal operations to a bare minimum,
- acquiring additional projects for specialists who still have some available capacity,
- limiting the support for existing products.
Mistakes in rates and offers
In Value Finance’s experience, mistakes in rates and offers are often caused by a few critical factors that cast a shadow on the entire budget. These things include:
- incorrect input data in calculations. If the parts of the project budget are rooted in the incorrect assumptions, they will lead to more and more grave mistakes later on. For example, if the values for chargeability are incorrect, the entire budget will be incorrect, too.
- incorrect cost estimations for offers for Fixed Price projects. In that case, the offers often include too few hours, leading to low or nonexistent profit margins. Calculating an Estimate to Complete and improving internal processes can solve this problem.
- imprecise calculations for company-wide costs (loads/overheads). They should be added to the costs of work in various teams; otherwise, the costs may get lost in the crowd and cause incorrect rates and offers. Use a cost allocation formula to avoid such situations.
What are the consequences of incorrect offers?
Incorrect offers and rates are usually the most serious mistakes a company can make. There are 2 main reasons for that:
- companies may start projects that have small profit margins or are unprofitable altogether. This is the worst case scenario for any company, as such offers cause the business to actively lose money instead of making it.
- the sales may grow while the profits fall. Every project requires additional specialists, tools and resources. If only a fraction of the projects generate reasonable profits, in a few months managers may find themselves with dozens of projects in their portfolio - and not a penny to their company’s name.
In both of these cases, the company's need for cash is growing rapidly, while the profits stay the same or even drop. If you find your business in that type of situation, you have to act immediately - here’s how to do it.
How to fix the problems with incorrect offers?
First, start with taking a closer look at the costs. Identify the project costs and separate them from general costs and overheads generated by administration, marketing and HR.
These calculations will help you determine the real costs of all the operations in your business - and the incomes the company should generate to cover them all and leave some profit to be happy about.
"Managers often have something calculated and they believe in it. They only realize they are in the wrong once they are audited. Then, it turns out that they make their decisions based on incorrect information."
Jakub Domeracki, co-founder of Value Finance
"At Primetric, we suggest many of our clients to divide their financial status into planned, tracked but unbilled and billed costs. This makes it easy to see what the plan was, how the execution is going, and how much of it we have already invoiced. Such a clear picture makes it easier to quickly understand the situation of projects or the entire portfolio"
Arek Terpiłowski, co-founder at Primetric
Then, provide your sales team with a customized calculator for creating offers. If you already have one in your company, make sure that the quality of calculations is on point; otherwise, you may only make things worse for your financial performance. Additionally, you should make sure that the same rates are used across the company; all of your teams have to be on the same page.
No control over general costs
Lack of control over general costs in the company means that there is no control over expenses outside the development team. This is a common problem for support departments, such as marketing, HR, Employer Branding and more. However, entire companies struggling with the issue are also common.
There are a few reasons why this happens:
- the costs are analyzed after they are generated and cannot be changed or adjusted,
- the costs are not sorted into categories and their origin is unknown,
- lack of documentation of the expenses, particularly the payments made with company’s cards,
- rising taxes caused by incorrect invoices,
- unnecessary tools and subscriptions.
How does the lack of control over general costs affect the financial performance?
The main problem caused by the lack of control over general costs can be described in just a few words: the money is spent ineffectively on unnecessary expenses, while it could do more good in some other fields. As a result, the funds do not improve the profitability - instead, they drag it down.
In other cases, companies spend too much money and make decisions they can’t afford. As a result, such businesses may accept projects or make investments that will stop them from growing in the long run - or will contribute to the company's collapse altogether. The same applies for working capital loans; while they may be tempting, they may also generate additional costs that may be harmful to the business in the months to come.
What can we do to prevent that scenario from happening?
Let’s start with the basics - each department in the company should have a budget and financial planning corresponding to its needs. It should only include the necessary expenses. Additionally, they should be regularly compared to the actual spendings, to ensure that every penny is spent on the right investments.
Additionally, finances should also become the responsibility of managers of particular teams and departments. Such an approach will help your business control the expenses on a smaller scale and ensure that they are really what they were planned to be.
Lack of budgeting for teams
No limit on spendings does not sound good - and, of course, it shouldn’t happen in any software company. Unfortunately, it does.
The main reason for such occurrence is the lack of financial education in teams. In service companies, people are responsible for generating expenses, as there are no materials, no storages, no machines. Their lack of understanding how things work may be another reason behind disappearing cash.
"I once encountered a perfect example of such behavior. A developer came to the executives and asked them to organize a hackathon. He needed 2 juniors, 2 mids, and 2 seniors, and 30 people could take part in the event. He also claimed that the event was capable of promoting the company. When asked about the costs of such an endeavor, the developer said that he only needed money for some social media posts; he thought that using the internal team for the purpose will generate no costs for the company."
Adam Zagała, co-founder of Value Finance.
Such irrational decisions involving unnecessary expenses may not be profitable for the company - and they often are not.
How can we improve the budgeting in the teams?
Just like we have suggested in the example from the previous paragraph, education is the key - and it should start with teams and their managers themselves. A set of workshops or classes aiming to show them the nuances of a company's finances can improve their awareness of such matters and help the business control their finances on both large and small scales.
Additionally, as the education continues, managers should also become responsible for financial matters. As they are always close to the team and its projects, they are the best people for the job - the company just needs to help them improve their financial abilities.
Improve your financial performance with Value Finance and Primetric
If you are still not sure how to improve financial performance in your company, we have a few more tips for you.
Secondly, if you still have some questions, feel free to visit Value Finance’s website and browse their offer - I’m confident you will find what you’re looking for there!