How to calculate the profit of a project?

In a professional services business, it is very important to monitor the profitability of projects. This indicator is crucial to growing your company, and ensuring that the activity as a whole is profitable. Service companies that sell projects must in fact be able to monitor the profitability of each project to be able to make the right decisions. Here we explain how to calculate the profitability of a project.

1. Why calculate the profit of a project?

It is particularly important to know the profitability of a project in a professional services activity. Consulting companies, agencies, and all activities that sell projects must track the margins of their projects. This indicator makes it possible to understand the possible reasons which penalize the profitability of the activity as a whole, and limit growth.

It is necessary to analyze the profitability of projects from several angles:

• Profitability by type of project

We must be able to analyze the difference in profitability between projects sold on a fixed price basis and projects sold on a time-based basis (on a management basis).

Generally, projects sold under management are less risky from the point of view of profitability since a sales price per hour or day is determined and this must theoretically already include a margin. However, it happens that not every day is billed or that fees penalize the margin.

Margin monitoring is even more important for projects sold on a fixed price basis. In this type of project, the project sales amount is fixed in advance and is not expected to change. If the work to complete the project is underestimated, there is a risk of cost overruns. Conversely, by optimizing the time spent on the project in relation to what was sold, it is possible to achieve a much greater margin.

• Profitability by team / Business unit

You need to be able to group projects and bring them together according to the analysis angles that may interest you: by team, by sector, by business unit. To do this, each project needs to have a “tag” to indicate which team, sector or business unit it is linked to so that the data can then be consolidated.

2. Create a project budget

The profitability of a project is compared to other projects, but also to the initially planned budget.

Creating a project budget at the start of the project is a key step in being able to monitor and improve performance. It is the measuring standard which allows, during the project, to know if we are deviating or if the project is at risk.

To construct a project budget, it is necessary to estimate the following elements:

• The time that employees will have to spend on the different project tasks
• The cost associated with this time spent by employees
• Subcontracting purchases when there are any on the project
• Costs which will have an impact on the margin (those which cannot be re-invoiced on the actual basis of the project)
• Any purchases of products, then used or resold as part of the project. For example software licenses

With all these elements, it is possible to calculate the set of costs expected for the project.

These costs are deducted from the forecast turnover of the project, which makes it possible to calculate the forecast margin of the project.

3. How to calculate the turnover of a project?

Theoretically, turnover is recognized when ownership of a good is transferred or when the service is fully performed. However, in the context of projects which may last several months, or even several years, it is possible to apply another methodology to recognize turnover as the project progresses.

The choice of methodologies applicable in your case must be validated by your accountant or your auditors.

The calculation of the turnover of a project must respect the accounting principles in force. There are several approaches to revenue recognition:

• Recognition of turnover based on invoicing

In this approach, revenue is recognized based on the amounts billed during the period. Billing = Turnover.

This is generally the method applied for cost-effective projects (billed based on time spent).

• Recognition of turnover upon advancement

At the end of each accounting period, a project progress rate is calculated (this rate must also comply with an accepted accounting methodology). The turnover recognized over the period corresponds to the amount sold multiplied by the progress rate, from which the amount of turnover recognized over the previous period is deducted.

This is a method often applied for fixed-price projects.

• Revenue recognition upon completion

For short projects, billing on completion is the most commonly used methodology. In this approach, revenue is recognized when the project is completed. To confirm this closure, the customer often signs a completion report or another document to prove that the service has been provided.

4. What costs should be taken into account in the project?

All costs that have been defined in the budget must be monitored, otherwise the scope of analysis is different between the budget and the actual.

Here are the costs that need to be tracked, and the best way to do so:

1. Costs of time spent by employees: A project management tool or ERP for your service company allows you to track time spent on project tasks and assign associated costs to each employee based on their salaries .
2. Subcontracting purchases : you need to take into account the costs of subcontracting on the project, either through subcontracting invoices or again through the ERP for your service company. Such software makes it possible to track subcontracting, whether it is linked to the time spent by an independent freelancer, or whether it is billed to you on a flat rate basis.
3. Non-rebillable costs and other purchases : you must include in the profitability analysis the costs associated with this project, such as travel, catering, computer license purchases, etc. Since the costs cannot be re-invoiced in reality, they will have an impact on the margin and must therefore be taken into account

5. Gross margin and net margin of a project, what is the difference?

Two margin levels can be calculated to provide specific indications.

• Gross margin : it deducts from the turnover all the costs applied to the project apart from the costs of internal staff. That is to say the costs of subcontracting, purchases and expenses spent on the project.

The gross margin is a very relevant indicator when a significant part of the project is linked to subcontracting

• Net margin : it deducts, in addition to the costs mentioned above, the costs linked to the time spent by internal staff. In this margin level, all costs linked to the project are therefore taken into account. This is the final margin of the project.

Stafiz helps professional services gain visibility and better manage their project progress thanks to real-time data, taking into account all costs and financial KPIs. Stafiz is a SaaS management resource planning , project management and Business Intelligence. This way, budgets and margins are always respected and you make better decisions for your business.

To learn more about the Stafiz platform, request a demo.

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