During a recent call with a CEO, we discussed the company’s profitability and what measure they used to drive profit – basically Profit/X. It became apparent that they didn’t have a handle on their costs and what they should be charging to ensure they hit their profit targets. I have addressed this a bit before to ensure that your margins were where you wanted and rejecting low-profit jobs. However, this time the issue is to understand the jobs’ profitability and price new jobs effectively.

The Costs

To determine profitability, we need to know our costs. Thus, we built a table listing every employee, the salary, additional expenses, e.g., health insurance, 401k, etc. (estimated at 35% of wages), and the amount of billable time. As a result, we had a table that looked like the one below.

Employee Costs

Calculate Hourly Costs

From this Table, we could determine the hourly cost of an employee. To calculate actual costs per hour, we took the number of billable hours, which for 2021 is 8,760, and subtracted 96 hours, the allowable PTO. However, most employees don’t work their total billable hours for various reasons, so we included a “slack” factor of 10%. For multiple reasons, most projects have “re-work” or errors that cannot be billed and estimated at 10% and included. As a result, the total “Billable Hours” was 7,800 rather than 8,760. These adjustments allowed us to produce the hourly cost for each employee.

Calculate Overall Costs

Taking that data, we then divided the hourly costs into billable and non-billable. We added fixed overhead, which was not related to billable expenses, e.g., CEO’s pay, office rent, etc. Thus, we now had a cost structure for the firm that looked as follows.

Billable Costs $1,099,150
Non-billable Costs 1,194,500
Overhead 750,000
Total Costs $3,043,650

Calculate Revenue

With the company’s cost structure defined, we could determine how much to markup hourly costs to make a 25% profit. Doing this analysis is easy in Excel; however, ensure you don’t make easy Excel mistakes. , and the result was that marking up hourly costs by 232% would enable the company to meet its profit goal. This analysis is shown below.

Revenue $4,056,895
Total Costs 3,043,650
Profit $1,013,245
Profit Margin 25%

 

Pricing of new projects

While I am a strong proponent of selling value, not time, if the company wants to know the minimum price to charge to realize its minimum profit, it can use this data. Identifying which employees will work on the project and for how long. For example, they would be able to cost it as follows:

Employee Hours Hourly Billable Rate Total Billable Charge
#3 25 $49.32 $1,233
#6 5 44.77 224
#10 20 43.83 857
#15 15 30.50 457
#17 10 48.67 487
Total     $3,258

With this data, we can now estimate jobs more effectively since we know the employees who will work on the jobs and how many hours they will commit. We have to build some waste into that model, but we have a good idea of how to price jobs.

 

Performance Table

Also, we can see either weekly, monthly, or quarterly how the company is performing. If we produce a table of the employees and clients and hours worked for a month, we can see the utilization of each employee and profit per client as follows.

Employee Utilization and Job Profitability

This table provides a good insight into the company’s and employees’ performance. As can be seen, Employees #3 and #6 are working more than their billable hours with utilization rates above 100%. While this may be good, one would need to ensure that whatever they were supposed to be doing with their non-billable time was being done. Also, Employee #9 is utilized 71.3% of the time, resulting in lost efficiency. Further analysis is required into why this is the case, but it identifies potential issues. Finally, it would appear that nearly half of the employees are working at less than 95% utilization. Given that the company’s utilization is already adjusted for “Slack” and “Rework,” analysis to understand why utilization is low is required.

We cannot only analyze employee performance, but we can see how we are doing with our various contracts. Clients #1 and #3 are losing money, while Client #4 is profitable. The data doesn’t tell us why, but again that would be work investigating as the company is performing below its goal of 25% profit.

Conclusion

As I stated at the beginning, concerning pricing, I strongly believe in pricing according to value and not hours; however, this analysis and methodology are helpful to understand what an organization’s minimum pricing should be and how it is performing. While several issues are highlighted and require more work, this provides a great way of knowing what to examine to improve performance.

If you would like to do this analysis, call me. I would be happy to help you.

Copyright © 2021, Marc A. Borrelli

Recent Posts

EOS is just that, an Operating System

EOS is just that, an Operating System

The EOS Model® provides a useful foundation for businesses, but it falls short in addressing key aspects of creating an growth. By incorporating additional elements from the Gravitas 7 Attributes of Agile Growth® model, businesses can create a more comprehensive system that promotes growth while maintaining smooth operations. Focusing on Leadership, Strategy, Execution, Customer, Profit, Systems, and Talent, the 7 Attributes of Agile Growth® offer a more encompassing approach to achieving success.

What has COVID done to Company Culture?

What has COVID done to Company Culture?

COVID has affected everyone. However, companies need to examine if they have lived their core values during COVID, how they are reinforcing them in a WFH environment, and especially with the onboarding of new hires.

Profit ≠ Cash Flow

Profit ≠ Cash Flow

Knowing how much cash you generate is essential for planning for growth. Too many companies don’t know and when they grow they find they are continually running out of cash. Understand your cash flow generation and how to improve it through improvements in your Cash Conversion Cycle and using the Power of One.

What Are Your Critical and Counter Critical Numbers?

What Are Your Critical and Counter Critical Numbers?

The key to achieving long term goals is to define short term goals that lead you there. Focusing those short term goals around a key metric is essential. However, ensure that the metric will not lead other areas astray by having an appropriate counter critical metric act as a counter balance.

Rethinking ‘Family’ Culture in Business: Fostering Performance and Success

Rethinking ‘Family’ Culture in Business: Fostering Performance and Success

Explore the importance of company culture and the potential pitfalls of adopting a “Family” culture in organizations. Learn how to foster a high-performance culture while maintaining key family values and discover success factors for family businesses. Rethink the “Family” culture concept and create a thriving environment for your organization.

Do You Truly Know Your Core Customer?

Do You Truly Know Your Core Customer?

Knowing the profit of your core customers is key to building a growth model. Many companies have identified core customers that are generating a sub-optimal profit and so they cannot realize the profits they seek. Identifying the correct core customer allows you to generate profits and often operate in “Blue Ocean.”

The Spectacular Rise and Fall of the European Super League

The Spectacular Rise and Fall of the European Super League

The European Super League (ESL) collapsed within 48 hours of its announcement due to hubris, a lack of value creation, and fan backlash. The founders’ arrogance led them to disregard European football’s deep-rooted traditions and culture. At the same time, the focus on wealthy club owners instead of merit undermined the essence of the competition. The fierce backlash from fans, who felt betrayed by their clubs, demonstrated the importance of prioritizing supporters’ interests in football.

Does Your Financial Model Drive Growth?

Does Your Financial Model Drive Growth?

Working with many companies looking to grow, I am always surprised how many have not built a financial model that drives growth. I have mentioned before a financial model that drives growth? Here I am basing on Jim Collin's Profit/X, which he laid out in Good to...

COVID = Caught Inside

COVID = Caught Inside

As we emerge from COVID, the current employment environment makes me think of a surfing concept: “Being Caught Inside When a Big Set Comes Through.” Basically, the phrase refers to when you paddle like crazy to escape the crash of one wave, only to find that the next wave in the set is even bigger—and you’re exhausted. 2020 was the first wave, leaving us tired and low. But looking forward, there are major challenges looming on the horizon as business picks up in 2021. You are already asking a lot of your employees, who are working flat out and dealing with stress until you are able to hire more. But everyone is looking for employees right now, and hiring and retention for your organization is growing more difficult.