Analyzing Employee Utilization Rates to Drive Profitability for Professional Services Firms
How utilized are your employees? What percent of their time is being spent working on projects that are not billable to the client? How much is that costing your company in productive capacity? If you do not know the answer to these questions, you could be missing out on potential revenue benefits.
For service-based organizations, analyzing employee utilization is imperative. Knowing where and how employees are spending their time enables professional services firms to:
- Appropriately set their rates
- Properly assess how much to invoice clients accounts
- Decide what to pay their employees
- Determine if they are over or understaffed
The Importance of tracking Utilization Rates and Billable Hours
Professional services companies spend a lot of time and effort around managing people. However, with many professional services companies, the crucial metrics of utilization rates and billable hours go overlooked or, at best under valued. Signature Analytics’ CEO Pete Heald and President Jason Kruger discuss best practices for all kinds of professional services companies who want to set pricing, hire staff and manage scope using accurate financial data.
Setting the Right Goals
For a professional services firm, setting accurate billable hour goals is foundational. However, as both Pete and Jason highlight, these goals can differ depending on the role. While lower-level employees might spend the bulk of their time billing hours to clients, senior-level personnel could be more involved in initiatives like sales, demanding a different metric for them.
Setting the right goals for the members of your team and then communicating them effectively and setting accountability around goal achievement are essential steps to managing using the data from your financials as opposed to being reactive to client demands or employee inspiration.
Checking in with leadership to assess each employee’s value to the company is important when setting these goals for billable vs non-billable hours. If someone isn’t billing hours, what are they contributing to the organization? Being clear on expectations and understanding where your people are ringing the most value is a crucial step to improving productivity and profitability.
What about fixed-fee Professional Services?
Even if a company operates on fixed fees, understanding the time and efficiency involved in each engagement is crucial. This ensures profitability remains on point, and businesses can set realistic and competitive fixed fees. Setting those fees should result directly from a granular understanding of the utilization rate and billable/ non billable horse of the team. IF the margins don’t add up, this data allows an owner to address pricing or bring in support to assess team efficacy.
Price setting is a little bit of a science and a little bit of an art. Even if a firm uses a fixed fee structure, determining an hourly rate is vital as it forms the basis for those fees. To determine this rate, Pete suggests starting with desired gross margins. For instance, if a firm targets a 40% gross margin and has clarity on the hours each team member works, they can backward calculate potential hourly rates.
Regular Tracking
Regularly monitoring billable hours – be it daily, weekly, or monthly – is crucial. Choosing the right project management software streamlines the process of tracking hours and managing staff. For most companies: even those with under a million in revenue, Excel spreadsheets just won’t cut it. Good project management and tracking software not only provides actionable insights into utilization but also assists in setting goals and managing to those goals Moreover, incorporating incentives for employees who meet or exceed their targets can bolster productivity and enhance value.
Hiring Decisions & Capacity Understanding
With accurate data in hand, a company can better predict when to hire the next individuals. This preemptive workforce planning approach ensures businesses aren’t scrambling to keep up with contracts after the fact but are strategically prepared for growth. Understanding current capacity helps in determining when to onboard new clients and when to expand the team.
Balancing Rates, Compensation, and Margins
Jason concludes by highlighting a trinity in professional services – the rate billed to clients, the compensation offered to employees, and the resultant margins. The market often determines billing rates, but they can also be a reflection of the unique value a firm offers vis-a-vis competitors. These rates, in turn, play a pivotal role in deciding employee compensation and the margins a firm can achieve.
In sum, while utilization and billable hours might seem like mere metrics, they lie at the heart of a professional service firm’s operational and strategic decisions. Firms that master these dynamics position themselves for both profitability and growth.
Calculating Employee Utilization Rates
The resource utilization rate is a balanced relationship between billable hours and working hours available and is a key metric of employee productivity.
For example, if there are 168 eligible working hours in the month of May and Penny spends 100.80 hours on billable client projects then Penny’s utilization rate is 60%.
Billable Hours / Eligible Working Hours = Utilization Rate
Now let’s say that Penny’s annual salary is $50,000, or $4,167 per month. In the month of May, she spends the remaining 40% of her productivity time on business development efforts (10%) and general and administrative (G&A) tasks (30%). That would mean the company is paying Penny $1,250 in May to work on non-revenue generating processes.
Monthly Salary x Time Spent on G&A (%) = Employee Cost
If this general and administrative time is benefiting the company then it may be worthwhile. Otherwise, this time could be used for other work, clients, or spent attending networking and other events to help grow the productive capacity of the business.
If Penny were to increase her utilization from 60% to 80%, her general and administrative employee costs would decrease to $417 per month – increasing efficiencies AND generating additional revenue.
Improving Employee Utilization Increases Profitability
From a revenue perspective, let’s assume that clients are billed at an hourly rate of $150. At 60% utilization, the company is making $15,120 in May; however, 80% utilization would bring in $20,160, or $5,040 of additional revenue. Furthermore, if you have 5 employees who can each increase their employee utilization rate from 60% to 80%, you could generate an additional $25,020 of revenue per month.
Higher Utilization = Increased Profitability
Using Utilization Rates to Guide Business Decisions, A Case Study
Earlier this year, Signature Analytics was hired by a professional services firm in San Diego to provide outsourced accounting services. In addition to performing monthly accounting maintenance and bookkeeping services (preparing financial statements, balance sheets, income statements, cash flow statements, etc.), we put together a Utilization Summary Report so the client would have visibility into their employee utilization rates month over month.
The metrics report revealed that in the month of January, the company’s average utilization rate for billable employees was 60% resulting in a $95k loss for the month. In February, average utilization was 63% indicating a consistently low utilization rate for the company. To show how utilization rates impacted the bottom line, we also compiled an “if-then” summary report which revealed that increasing average utilization to 75% would generate a profit of $130k for the month.
Using this utilization percentage information, the company decided to make personnel changes in the month of March that would increase its profitability. This included letting go of an underperforming non-billable sales associate. They also replaced a billable-time employee with consistently low utilization with a new billable employee whose skills and capacity could be better utilized by the company. Additionally, the firm set personal billable utilization goals for every employee to help encourage the staff to improve productivity and maximize billable projects and hours.
Following the changes, average employee utilization increased to 76%, resulting in a profit increase of $230k for the month of March.
Read another case study: Unknown employee utilization causing unknown or inaccurate client profitability.
Talk to An ExpertImprove Your Firm’s Utilization
At Signature Analytics, we help several professional services firms use utilization rates to make key strategic decisions that drive profitability. Preparing utilization summary reports and “if-then” analyses are one way we enable our clients to visualize the effect of increased utilization rates. We are also able to show the company key metrics for unbilled general & administrative time by applying utilization rates to salaries and separating these wages on the financial statements. Furthermore, we have helped clients implement time tracking systems – which is the first step in determining utilization rates – and assisted with the development of company policies to ensure time is accurately entered by employees.
