1. Overcomplicated payments = additional costs
Many companies, especially the small ones, tend to change the price of the working hours throughout the project; the more the hours, the lower their price. Others tend to combine time & material with fixed price projects in settlements for a single project. However, such an approach to project budgeting may be very unprofitable - and you may not even know about it!
The simpler the structure, the better the finances
While lowering the price as the project goes may be tempting for a customer, for a provider it may quickly turn into a disaster. Such changing price:
- makes it very difficult to forecast the costs of a project,
- is a root cause of all types of error in the final invoices and may be a reason for the loss of trust in the company-customer relationship,
- makes every working hour less profitable,
- generates thousands of dollars in additional costs of just calculating the values,
- makes your processes unscalable; with them, your company simply cannot grow.
In other words: overcomplicated payments may attract customers, but they also may ruin your company’s budget!
How to keep the finances simple?
70% percent of our customers simplify their financial structure as they grow - and they grow even faster with very basic processes. This is no accident: that is simply the best response to any costs generated by overly complicated processes.
The largest companies we cooperate with only have three financial types of projects:
- fixed price,
- time and material,
As a result, they perfected their financial monitoring and became capable of keeping track of every single penny without wasting thousands of dollars on pointless calculations.
2. Selling fixed price projects = dropping profitability
But what if some types of financials in projects were more risky than others?
That is actually the truth for fixed price projects. While they are definitely a bargain for customers, for IT services companies they may be difficult to be profitable - especially in a longer perspective. For example, some of our customers were surprised to discover that their FP projects generated a 4% loss!
Why fixed price projects can turn out to be unprofitable?
There are few reasons for that:
- their profit margin changes with inflation over the years,
- they often generate additional costs that are included in the project scope, but not in the budget,
- they had to be completed regardless of the costs, unless the contract states otherwise.
In short, they are not flexible enough to keep up with the changes in the environment.
Which fixed price projects are the most profitable?
Not all fixed price projects are to be demonized - some of them can turn out to be very successful, too.
So-called quick fixes, or small, product-based projects are often some of the most profitable. Because they are generally short-term endeavors, their scope of work can be accurately assessed and priced, giving the companies an opportunity to generate huge profits.
Some of the long-term fixed price projects can be profitable, too, provided that your company has experience completing them. So-called gray-haired project (or simply projects that your business have delivered successfully numerous times) can be accurately estimated and conducted in a predictable manner, becoming a reliable source of profit.
3. Failing to include time offs in project plans = inevitable delays
In some cases, the comparison of planned and actual project margins can be a harsh experience. But why?
In our experience, unrealistic plans are usually to blame. Numerous companies plan their people for 160 hours a month, regardless of their actual availability that is hugely affected by time offs, sick leaves, and other responsibilities. As a result, the costs of work and additional allocations grow, and so are the delays, taking a toll on the project budgets.
Importantly, we are not talking about small financial differences, too; in some cases, companies experienced a 25% drop in their margins, effectively losing a quarter of their profits.
How can I make my plans and margins more realistic?
To assign the right people to the project, you need to calculate the actual capacity (the maximum available number of hours an employee can spend working in a given period) of a specialist you want to assign, and compare it to their utilization, or the time they are already sure to spend on other responsibilities. The difference between the two values will give you information on the number of available hours an employee can spend in your project.
Alternatively, you do not have to calculate these values manually. Some capacity planning tools, including Primetric, use the plans and time off information to calculate the availability of all the employees and provide managers with it when they are looking for the right people for the job.
4. Overly optimistic allocations = delays and additional costs
In our experience, many companies decide to use approximate data on the number of hours necessary to complete an assignment, as well as their cost. However, this approach rarely pays off.
Let’s imagine a manager that wants to assign a specialist to a very simple project. However, he did not take a look at neither calendar nor the budget and, based on his experience, he assumed that an average hourly rate for such a developer is $30 dollars. He also used his past projects to estimate that this operation will take 100 hours.
Based on the data, the project would cost $3000 dollars. Happy with the result, they asked the customer to pay $5000 for the operation, being left with a 66% margin.
However, when the manager was about to schedule a project officially, he noticed that the developers with hourly rate below $30 are simply not available. As a result, he had to settle for a more expensive employee, costing $40 per hour.
To make things worse, the developer has discovered that he won’t be able to complete the project in just 100 hours - he needs at least 120 hours. Therefore, the costs of the project have suddenly increased to $4800, leaving the overly optimistic manager with just $200 profits; enough to wipe his tears away.
How to allocate people and costs and make no mistakes?
There is only one way to avoid the problems that the manager from the story above have in his work: it is working on the real data instead of assumptions and wishful thinking.
When planning a project - or even acquiring one in the first place! - check the availability of your people and use that information to allocate them. Do the same for their salaries or wages to complete budgeting. Only then you will avoid ruining your profit margins!
5. Incorrect time tracking = miscellaneous expenses
A few years ago, there was a company that wanted to track time and use the information to calculate the costs of work. However, they have decided their employees will only track 7 hours a day, instead of 7, as they waste some of their time on breaks and organizational tasks anyway.
However, when the time came to sum up the company’s finances, it turned out that around half a million dollars was spent on unknown activities, as the untracked hours were still generating costs.
And you wouldn’t like to be the one to actually lose a half a million dollars, would you?
How to correctly track time and combine it with the finances?
There are a few steps you need to take to do that.
First, assign an hourly wage to all of the employees. If they have a monthly salary, calculate their hourly rate based on the number of hours they spend working.
Then, introduce the time tracking process to your company. Remember to educate employees on its importance - many of them will deem it a bureaucracy and refuse to take part in the process. Show them that their time will have a direct impact on the invoices!
To add to that, simplify time tracking as much as possible. Do not make your employees track their time in too much detail or in two tools at the same time! It will just increase their resistance.
Last but not least, do not be afraid to enforce time tracking amongst your employees. If necessary, tie the tracked hours to their wages, or try some other ideas that may help your company that were successful in the businesses of our customers.
6. No historical data = no profits
Imagine that you have a retainer project that is supposed to take 10 hours a month, and, regardless of the effort, the customer will pay the same price. However, when you look at the time tracked in the project in the past few months, you discover that it only took 6 hours to complete. In other words, your employer could have done 4 hours more of billable work, and you simply didn’t know about it. You certainly wouldn’t be happy about such a turn of events, would you?
And what if that happens in dozens of different projects?
Assuming the ratio of actual worked hours to planned hours stays the same, the company will lose 40% of its employees’ time, and it will miss the opportunity to acquire more projects that could generate profits.
How to use the spare hours to generate profits?
First, you need to know how many hours you can use to generate additional profits.
To do that, your team needs to track time every day and pay attention to the amount of time they spend on each of their allocated tasks. Then, you can begin to look for some spare hours in their timesheets to determine which projects take less time than previously estimated.
Then, you can use the data to:
- create a more accurate plans for the projects you already manage and optimize their costs by assigning less hours to them,
- assess the number of hours your employees could spend working on other projects,
- acquire or expand projects requiring their skills and using specialists’ time to generate profits in such projects instead of spending them on idle allocations.
7. Do you want to manage your profit margins even better?
Great - you’ve come to the right place!
Visit our blog to also read about:
- project financial analysis,
- improving financial performance in the IT company,
- methods of avoiding cost overrun,
- cost allocation that will help you improve your finance management processes,
or, if you already know you need some help calculating your profits, book a demo with our advisors or start a trial with Primetric!