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.
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 any business that sells projects need to track their project margins.
This profitability indicator enables us to understand any reasons that are penalizing the profitability of the business as a whole, and limiting growth.
Project profitability needs to beanalyzed 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 speaking, projects sold on a fee-for-service basis are less risky from a profitability point of view, since a selling price per hour or per day is determined, which in theory should already include a margin. Sometimes, however, not all days are invoiced, or the margin is penalized by charges.
Margin monitoring is even more important for fixed-price projects. In this type of project, the amount to be sold is fixed in advance and is not expected to change. If the work involved in completing the project is underestimated, there is a risk of cost overruns. Conversely, by optimizing the time spent on the project in relation to what has been sold, it is possible to achieve a much higher margin.
Profitability by team or Business Unit
You need to be able to group projects together according to the angles of analysis that might interest you: by team, by sector, by business unit.
All that's needed is for each project to have a "tag" indicating which team, sector or business unit it's linked to, so that the data can then be consolidated.
Create a project budget
The profitability of a project can be compared not only with other projects, but also with the initial budget.
Creating a project budget at the outset is a key step in monitoring and improving performance. It's the yardstick by which, during the course of a project, we can tell if we're off track or if the project is at risk.
Stafiz allows you to monitor your profitability by constantly recalculating the production value compared with the initial budget.
To construct a project budget, it is necessary to estimate the following elements:
- the time employees will have to spend on the various project tasks ;
- the cost associated with this time spent by employees ;
- subcontracting purchases, where applicable to the project;
- costs that will have an impact on the margin (those that cannot be re-invoiced in real terms for the project);
- any purchases of products used or resold as part of the project. Software licenses, for example.
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.
How to calculate project sales?
Theoretically, sales are recognized when ownership of an asset is transferred or when the service is fully performed.
However, for projects that may last several months or even years, it is possible to apply a different methodology for recognizing sales as the project progresses.
The choice of methodologies applicable in your case must be validated by your accountant or your auditors.
The calculation of project sales must comply with current accounting principles. There are several approaches to sales recognition, which require a good knowledge of the financial indicators used in project monitoring.
Recognition of turnover based on invoicing
In this approach, sales are recognized on the basis of amounts invoiced during the period, enabled by accurate time tracking. Invoicing = Sales.
This is generally the method applied for cost-effective projects (billed based on time spent).
Your recorded times are automatically converted into invoices.
Recognition of turnover upon advancement
At the end of each accounting period, a project progress rate is calculated (this rate must also comply with a methodology accepted for accounting purposes).
Sales recognized for the period correspond to the amount sold multiplied by the rate of completion, from which the amount of sales recognized in 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.
Stafiz is an ERP for professional services and service companies. Find out how to better manage your projects, monitor their progress and improve margins.
What costs should be factored into 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:
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- Costing employee time: a project management tool or ERP for your service company lets you track time spent on project tasks and assign associated costs to each employee based on their salaries.
- Subcontractor purchases: you need to keep track of the costs of subcontractors on the project, either through subcontractor invoices, or again through ERP for your service company. Such software enables you to track subcontracting, whether it's linked to the time spent by a freelancer, or whether it's billed to you on a fixed-price basis.
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.
- Non-rechargeable costs and other purchases: you need to include costs associated with this project, such as travel, catering, computer license purchases, etc., in yourprofitability analysis. Since these costs cannot be re-invoiced in real terms, they will have an impact on the margin and must therefore be taken into account.
What's the difference between a project's gross margin and net margin?
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 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: in addition to the above-mentioned costs, this deducts the costs of time spent by in-house staff. All project-related costs are therefore included in this margin level. This is the project's final profitability margin.
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.
