What is profitability? Definition
Profitability is a measure of profits yielded by a business or a part of its activities - for example, a project. Profitability is an important factor in analyzing financial performance and it is one of the main indicators of the company’s success for most businesses.
In this article, however, we will focus on the most general profitability - the one calculated for the entire company and its entire customer base.
How to improve profit margins in a company?
Simplify the settlements
Do you know what has the most profitable and fastest-growing IT services in common? The simplicity of budgeting and recurring income that allows them to answer the key questions on their finances on a daily basis.
How to find the highly profitable operations in your business?
Calculate the costs of each working day for each developer to accurately estimate the costs of work. In the same way, you can also make sure that they do not waste their time on non-billable tasks.
Use the same information to allocate people and stay in the budget. In the same time, you will also simplify the settlements with customers and minimize the risk of non-billable utilization.
Try to allocate projects in a longer perspective and, if possible, use the SaaS model that provides you with a stable, recurring income. Any additional work outside of the initial scope can be settled separately when necessary.
Monitoring billable and non-billable hours
The majority of IT companies work on both commercial and internal projects. However, some of them seem not to realize that internal work may eat up all the profits generated by projects ordered by the customers.
Monitoring the billability of specific tasks
To make sure that the majority of work is done in a projects ordered by the current customers, you need to monitor both billable and non-billable hours, especially for key people in your projects If the ratio of billable to non-billable hours is dropping, your commercial projects may soon not be able to cover the costs of all the operations, putting your company in a difficult position.
Calculating the profitability of projects using cost allocation formula
In IT service companies, projects are the main source of income, while the people that complete them are the source of costs. Therefore, you should calculate their profitability not only after they end, but also before they start and while they are in progress.
How to calculate the profit margins for existing customers?
Still, it’s easier said than done. That’s because projects have to cover not only the costs of working hours and basic equipment, but also a fraction of company-wide expenses, such as rent, bills, or operations of supporting departments, such as marketing or sales. Therefore, finding the most profitable customers with high profit margins may be a bit tricky.
Taking all these features into account may drastically change the financial performance of your projects, as well as its profit margin and the state of its cash flow - and that’s what a cost allocation formula is for. If you want to learn more about spreading the operational costs evenly in all your projects, this is definitely a source for you!
Preparing an analysis that includes all of these factors is not a piece of cake; that is why we wrote a separate article about project financial analysis - feel free to read it now!
The majority of service companies profit from their employee’s time. However, in some cases, it is not used to the maximum extent, generating less money than expected. Monitoring utilization can help you prevent that from happening.
How to calculate utilization?
To calculate utilization per employee, you simply need to divide the time they spent in billable projects by the maximum number of hours in a given period they will be at work.
Importantly, notice that the desirable utilization rate may differ depending on the seniority of the employee. For example, a junior developer should be busy 95% of the working time, as he typically works on a single project that requires no further action to be processed. A senior developer, on the other hand, has an utilization of around 50-65%, as, apart from coding, he also takes part in a variety of additional activities, including meetings with the customer, workshops and internal activities.
Because of these differences, an average utilization rate for a company should be around 75-85%, depending on the number of senior employees.
How to monitor utilization?
While we all try to strive to improve the utilization rate, sometimes it is simply not what we expect it to be. But what can a manager do to change that?
First of all, the number of non-billable activities should be verified. While breaks and meetings are necessary, some activities should be omitted, as they do not generate any profits for both the company and its customers. Remember that every hour of work costs money, while only the billable hours generate profits!
Secondly, plan and monitor the workload. Use dedicated tools to be as precise as possible, avoid schedule conflict, and spot idle employees before they become a source of additional costs while generating no profits.
Last but not least, reduce the number of benched employees. They still need to be paid, but they will only generate profits when assigned to the project. Look for new projects if you see that a large group of developers is about to be bored at work!
Can I forecast utilization?
Yes, of course!
Using resource management tools, you can plan your work, monitor its progress and see when projects end. As a result, in cooperation with the sales department, you can start looking for new projects before your company’s bench becomes crowded. The same tools can also be used to find inefficient employees or simply people who would be much more profitable elsewhere.
Measure the cost of benched employees
Many managers in the IT industry tend to think that they do not have enough specialists. However, this may just be an illusion - when their utilization is not calculated properly, the workers may seem much busier than they really are. As a result, they spend half of their time benched, generating costs.
How to prevent unnecessary costs from benches?
To prevent the costs of the bench from growing exponentially, measure the costs of people that are not assigned to active projects. If you see that your bench is starting to get crowded, try to find a new project for the people that are going to be idle for the foreseeable future. By doing so, you ensure that company’s money is not spent on just keeping the employees there, and you may even make some additional money with the new projects!
Additionally, with recession just around the corner, the number of projects may drop further, expanding the bench exponentially. Calculating the utilization in that case is particularly important, as it can show you the costs of idle employees and help you make better decisions.
Improving the efficiency of processes
As a business owner or a manager, you should know that some costs are not worth their price in the first place, and they could - and should - be cut off from your budget. Others, on the other hand, may be ineffective and cause your business to lose customers. In both cases, such occurences can be spotted by throughout analysis.
How to find the key performance indicators for efficiency?
To improve the profit margin of your company, analyze its financial statements on a regular basis. In this process, you should focus on finding:
- any spendings that can be eliminated right away, as they are not necessary,
- unknown expenses that should be allocated and evaluated,
- any operations that were not included in the budget for a department, team or the entire company (depending on the situation),
- commercial processes with small profit margins,
- any other processes responsible for generating additional expenses while having no significant income.
After finding any of the costs above, analyze them thoroughly to determine whether they were really necessary and simply worth the money. If they are not - it’s time to cross them out from future budgets!
Every project manager and executive knows that every project, team and department, as well as the whole company, needs to have a budget. However, some of them often forget that the budget is not yet another document supposed to gather dust on the shelf in the back of your office. Budgets should be monitored, evaluated and changed when necessary!
How to improve company's profitability by budgeting?
To gain better control of your cash flow and improve business profitability as a result, you should:
- start time tracking in your projects. In the majority of cases, tracked time is what generates the majority of costs in projects. Track them and use the hourly rates and salaries to determine the real cost of work in the real time.
- include overhead costs in budgets. Both one-time spendings, such as new equipment and raw materials, and the recurring costs, such as subscriptions, should be included in the budget. Without them, you may be under the impression that your operating expenses are lower than expected!
- monitor the changes in the budget. As the project goes on, the costs of work and other expenses are rising, and the quality control may go downhill. Use the combination of time tracker and budgeting to keep track of these changes and react whenever a sharp spike in costs appears.
Continuous market research
Service companies, and IT companies in particular, are subject to constant changes. Still, you cannot just let your company be surprised time after time when these changes appear. You need to prepare for the future to increase profitability - and that’s what market research is all about.
The aim of the market research is to help project managers and executives to get an idea of what customers want now, how their needs change, and what they may want in the future - andn which new markets may be interested in their product category. In other words, a simple survey or report can help you see how your products and services may improve to attract new customers and increase profitability.
Improving employee satisfaction and engagement
If you have ever had any contact with HR specialists, you certainly know that hiring a new specialist is not only a burden, but also a very costly endeavor. That is why you can improve profitability in your company by ensuring the lowest possible turnover rates.
Increasing profitability with higher morale - how to do it?
Sufficient wages, high-end employee development, friendly environment and rewarding responsibilities are the key to attracting new employees and convincing the existing ones to stay with the company for longer. Additionally, all these things are also valuable from a business perspective: they allow you to save money on hiring new specialists, and they improve profitability by increasing the value of their work.
Eliminating non-essential factors
Is the new coffee machine really necessary? And what about that tool - do we really need another platform for graphic design? Additionally, I do not think that attending this conference would be worth the money… Increasing profitability may be all about getting rid of such factors, as their perceived value may be higher than it is in reality!
How to eliminate such factors from business processes?
Let’s face it - regardless of the size of the company, some additional, unnecessary spendings simply happen. However, you simply need to put an end to some of them (of course, some may prove really useful!).
When trying to improve profitability in your company, pay particular attention to such extra spendings. While they may seem quite small, when summed up they may be responsible for a large pile of money disappearing from your bank account.
Find and acquire profitable types of projects
Not all projects are made equal - some of them may simply be more profitable than others. Your objective is simple: to find them and make sure there are more of them!
How to improve gross margin with better choice of projects?
By analyzing the financial condition of all the projects (for example, using a report we show below) you can see exactly which ones are the most profitable, and which ones turned out to be less than satisfactory. By looking at such a summary, you can choose the types of projects that perform best and focus on their acquisition in the future, boosting company's profitability, finding better deals and cutting costs of product or service that other businesses have gotten rid of years before.
Reducing costs, of couse, makes sense in increasing profitability, but it is not the only way to create profitable products or making the projects cost effective. In the IT industry, people’s skills and work are the main source of profit. Therefore, boosting productivity is the easiest way to improve profitability, too.
How to make more money by boosting productivity?
To do that, you need to:
- realistically plan people’s capacity. Only around 80% of a specialist's capacity should be assigned to a project. The rest of the time will be spent on organization, breaks and meetings anyway!
- monitor the billable and non-billable hours. Some employees may simply waste their time on internal projects while they could be making money on the commercial ones. Make sure that is not the case.
- avoid overtimes and benches. While sometimes inevitable, overtime and benches have a huge negative impact on people’s motivation and productivity. Therefore, make sure such problems occur in the project schedule as rarely as possible.
- avoid schedule conflicts. Due to mistakes or lack of staff, some specialists may find themselves assigned to two or more projects - and they won’t be able to do that much work.
How can I do all of these things?
Just take a piece of paper and… you better put it back in the drawer.
Such complex calculations cannot be made in a notebook or in an Excel - there are way too many factors that may affect its final results. That is why the majority of IT companies use some more intricate tools, such as Primetric.
What financial features does Primetric offer?
Primetric includes a variety of tools that can help you assess the financial condition of your company both in general and in detail. Its features include:
- time and financial estimates for new or prospective projects,
- advanced budgeting and settlements for projects that are already in progress,
- an option to calculate different margin degrees, depending on your needs,
- the costs of work in a project calculated in the real time based on the amount of hours worked and information on wages or salaries included in the system,
- detailed financial information for each of your projects, including project overheads, company overheads, and more,
- a wide range of advanced reports, including profitability, productivity, and more.
Of course, that’s just a fraction of the features you can find in Primetric - we also offer time tracking, business intelligence, project portfolio management, and more.
Naturally, you do not have to take our word for
Want to learn more about finances for your business?
No problem - we have a few articles you may find helpful. On our blog you can read about:
- financial performance and how to measure it,
- Jira invoices and other financial features,
- billable and non-billable hours (and why you should use them),
- measuring business performance,
- forecasting revenue.