How to calculate the profit of a project?

In a professional services business, it's very important to keep track of project profitability. This indicator is crucial to the company's growth, and to ensuring that the business as a whole is profitable. Service companies selling projects need to be able to track the profitability of each project, so they can make the right decisions. Here we explain how to calculate project profitability.

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 tobe analyzed from several angles.

Profitability by project type

We need to be able to analyze the difference in profitability between projects sold on a fixed-price basis and those sold on a time-and-materials 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;
• 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's possible to calculate the total cost of the project.

These costs are deducted from the project's forecast sales, enabling us to calculate the project's forecast margin.

How to calculate project sales?

Theoretically, sales are recognized when ownership of a good 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 to your case must be validated by your chartered accountant or 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.

Sales recognition 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 used for time-and-materials projects.

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 method is often used for fixed-price projects.

Recognition of sales on completion

For short projects, invoicing on completion is the methodology most often used. In this approach, sales are recognized when the project is completed. To confirm this, the customer often signs a statement of completion or other document proving that the service has been rendered.

What costs should be factored into the project?

All project costs defined in the budget must be tracked, otherwise the scope of analysis will differ between budget and actual.

Here are the costs you need to track, and the best way to do it:

1. 1. 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.
   2. 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.

Discover subcontracting management

1. 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: deducted from sales are all costs applied to the project other than internal staff costs. In other words, subcontracting costs, purchases and expenses incurred on the project.

Gross margin is a highly relevant indicator when a large part of the project involves 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 to gain visibility and better manage their project progress thanks to real-time data, full costing and financial KPIs. Stafiz is a SaaS solution for resource planning, project management and business intelligence. As a result, budgets and margins are always respected, and you can make better decisions for your business.

To find out more about the Stafiz platform, request a demo.

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