How to calculate the profit of a project?

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

Why calculate the profitability of a project?

Knowing the profitability of a project is particularly important in a professional services business. Consulting firms, agencies, and all activities that sell projects must follow the margins of their projects.

This profitability indicator makes it possible to understand the possible reasons that penalise 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

It is necessary to be able to analyse the difference in profitability between projects sold on a fixed-price basis and projects sold on a time-spent basis (under direct management).

Generally, projects sold by a public company are less risky from the point of view of profitability since a selling price by the hour or by the day is determined and this must theoretically already include a margin. However, sometimes not every day is billed or fees penalize the margin.

Margin tracking is even more important for fixed-price projects. In this type of project, the sale amount of the project is fixed in advance and is not supposed 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 compared to what was sold, it is possible to make a much higher margin.

Profitability by team or Business Unit

You need to be able to group projects and group them according to the angles of analysis that may interest you: by team, by sector, by business unit.

All that is needed is for each project to have a "tag" to indicate which team, sector, business unit it is linked to in order to then be able to consolidate the data.

Create a project budget

The profitability of a project is compared to other projects, but also compared 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 measurement standard that makes it possible, during the course of the project, to know whether we are deviating or whether the project is at risk.

Stafiz allows you to monitor your profitability by constantly recalculating the valued production compared to the initial budget. 

To build the budget for a project, it is necessary to estimate the following:

• the time that employees will have to spend on the various tasks of the project;
• the cost associated with this time spent by employees;
• subcontracting purchases when there are any on the project;
• the costs that will have an impact on the margin (those that are not rebillable on the actual basis of the project);
• any purchases of products, which are 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 expected costs for the project.

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

How do you calculate the turnover of a project?

Theoretically, turnover is recognised when ownership of an asset is transferred or when the service is fully performed.

However, in the context of projects that can last several months or even 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 auditors.

The calculation of a project's turnover must comply with the accounting principles in force. There are several approaches to recognizing turnover, which requires a good knowledge of the financial indicators used in project monitoring.

Recognition of turnover based on invoicing

In this approach, turnover is recognised on the basis of the amounts invoiced during the period, made possible by precise time tracking. Billing = Revenue.

This is generally the method applied for projects under direct management (invoiced by time spent).

Progress-based Revenue Recognition

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 recognised over the period corresponds to the amount sold multiplied by the rate of progress, from which the amount of turnover recognised over the previous period is deducted.

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

Recognition of turnover on completion

For short projects, invoicing on completion is the most common methodology. In this approach, revenue is recognized when the project is completed. To ratify this closure, the client often signs a report of completion or another document justifying that the service has been provided.

What costs should be taken into account in the project?

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

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

1. 1. Employee time costs: A project management tool or ERP for your service organization allows you to track time spent on project tasks and assign associated costs to each employee based on their salaries.
   2. Subcontracting purchases : you have to take into account the costs of subcontracting on the project, either through the subcontracting invoices or again thanks to the ERP for your service company. Such software allows you to track subcontracting, whether it is related to the time spent by a freelancer, or whether it is billed to you at a fixed rate.

Track the performance of your external collaborators

In Stafiz, your externals are included to collaborate directly from the platform through specific accesses. Time entry is simplified, and their invoices can be shared directly with you.

Discover the management of subcontracting

1. Non-billable expenses and other purchases : You should incorporate the costs associated with this project, such as travel, catering, IT license purchases, etc., into the business case . As soon as the costs are not re-billable on an actual basis, they will have an impact on the margin and must therefore be taken into account

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

Two levels of margin 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 the internal staff. That is to say, the costs of subcontracting, purchases and expenses spent on the project.

Gross margin is a very relevant indicator when a large part of the project is related to subcontracting

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

Stafiz helps professional services gain visibility and better manage their project progress thanks to real-time data, the consideration of all costs and financial KPIs. Stafiz is a SaaS for managing the 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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