Financial Measures for Managing Professional Service Projects

This note is tilted towards ‘Software Testing’ as a professional service....

"Gross Profit Margin" is one of a key financial KPI, projects must measure, monitor and act upon. It is a key to maximum profitability. The gross profit margin is what allows the company to function. The higher the percentage, the more you can grow. The lower the percentage, the closer you are to a negative cash flow."

What is the difference between Gross profit and the Net Profit for a company?
Gross profit is the $ value left over from the firm's revenue after deducting the direct costs incurred in earning that revenue. Gross profit margin is the gross profit $ expressed as a % of the revenue. So, if gross profit is $1000 and the revenue was $10,000 then the gross profit margin is ... 1000 divided by 10,000 = 10%. This is a measure of the firm's profitability being obtained from it's core activities.

Net profit is the $ value left over from the gross profit after deducting the overheads. Net profit margin is the net profit $ expressed as a % of the revenue. So, if net profit is $500 and the revenue was $10,000 then the net profit margin is ... 500 divided by 10,000 = 5%. This is a measure of the firm's overall profitability, performance and sustainability.

Expressing these measures as a % allows for an easy comparison with the firm's prior year's performance, with other competitors within the same industry and with other industries. Separating the gross profit from the net profit allows to precisely identify where in the firm's operations a profit problem or profit benefit is located. Gross Profit margin also allows for profit comparison between different services offered by the firm to identify those that make the greatest contribution to paying for the overheads and those making the least.

How can we calculate Gross Profit Margin of a project?
(Total Services Revenue - Cost Of Services) / Total Services Revenue

Total Services Revenue is any / all revenue, team delivers. This would include both Managed Services Revenue and Professional Services (consulting, project). You can calculate different margin rates per type of services.

Cost Of Services is the total direct costs associated in delivering services, which includes not only the obvious base salary but any incentives to the team, parking, mileage, laptops, software, benefits, travels etc.

It doesn’t include any overhead or indirect costs such as rent, utilities, technology, office supplies, training, health insurance, sales & marketing, administrative cost etc.
MSP Key Performance Indicator: Services Gross Margin

What is an ideal gross profit margin?
If you have the project management in your hand, hard numbers to have in mind could be -

• Never less than 30%
• 40% is very good
• More is always welcome

What can be done to increase Gross Profit Margin in a project?
Below measures can be taken in a project to increase the Gross Profit Margin

Increase of Billing Rate (Hourly rate)
Most small business owners feel that if they raise prices, they will quickly lose customers, thus offsetting any additional profit they might earn. Though this is not always a favorite of small business owners, raising prices can actually work to their advantage. The most basic way to increase margins is to increase prices. If you’re currently earning a 15% gross margin, and you want to increase it to 25%, increase your bill rates by 10%

Billing Utilization (Don’t lose yours billing)
This metric is the percentage of time you can bill to clients. Billable hours reflect your employees’ time spent specifically on revenue-generating activities (i.e., project tasks). Billable utilization is a critical concept for firms that make money by billing out resources (people) to customers. Billing utilization might be low due to -

• Excessive leaves being taken
• Scope of the project is not defined properly
• % of billable work is written off due to not meeting the expectation
• Less number of hours billed in the invoice mistakenly
• Resources working in the project are not being billed (buffer resources)

Profit Per Employee
Another important measure to consider for improving gross profit margin is to improve profit per employee -

• Try improving the pyramid, when project size is big
• Consider maintaining healthy profit margin for each employee when project size is small or having a flat structure

Other Direct Cost
Apart from employee salary cost, try minimizing others costs like -

• Cost of devices being used in the project
• Licensed softwares being used in the project
• Travel cost associated with the project

It might also needs to be keep in mind that while improving the gross profit margin, employee retention must also be considered because attrition of employees might bring down the average gross profit margin in the long run.