Understanding margins is the cornerstone of any successful business strategy. Signature Analytics’ CEO, Pete Heald, and President, Jason Kruger, recently emphasized the importance of deep comprehension of your business’s margins, the influences that shape them, and the opportunities they present for improvement.

Why Knowing Your Margins is Essential

Margins, the difference between the selling price of a product or service and its cost, are a primary indicator of a business’s profitability. It’s not enough to understand the overall margin; businesses must also grasp the margins for individual product or service lines. As CEO, Pete Heald points out, having this understanding allows for effective measurement and goal setting.

Increasing the gross margin – the profitability after subtracting cost of goods sold (COGS) – even by a single percentage point can lead to significant improvements in a business’s bottom line. In a $10 million revenue business, for example, a 1% improvement in margin equals an additional $100,000 in net income. That much additional cash on the bottom line can make a huge difference in how a business makes decisions about inventory purchasing, hiring and workforce planning, real estate costs and many other operational choices.

Understanding Your Trends

Margins, much like other financial parameters, can trend upwards or downwards over time. Businesses need to mine these trends for the valuable insights they provide. A decreasing margin might signal a need for proactive adjustments, while an improving margin could indicate the effectiveness of certain strategies.

For example, if a $10M business can increase the price of a product by 2% while COGS remain the same, they will see an additional $200,000 bump to the bottom line. Understanding the details that drive these dynamics allows a business owner and leadership team to make strategic decisions to improve gross margin and profitability.

Beyond Gross Margin

Improving gross margin is only part of the puzzle. Businesses must also focus on managing their Selling, General & Administrative (SG&A) expenses to improve their net income margin. CEO, Pete Heald emphasized that the key to managing SG&A costs lies in understanding your numbers, trends, and what constitutes your margins by service or product line.

Once businesses have a firm grip on their margins, they can explore various strategies to enhance them. This could include sales strategies, purchasing strategies, or re-evaluating shipping agreements to name just a few. For businesses that manufacture or buy products, these elements can significantly impact margins.

Ultimately, the importance of margins cannot be overstated. They’re an essential part of the financial health of any business. As President, Jason Kruger stresses in the video above, small improvements of even 1-3% can make a substantial difference to a business’s bottom line, reinforcing the importance of not just understanding your margins, but also continually striving to improve them.

Right-Sized Teams at the Right Time

One of the things we looked at as we were going through the end of Covid and into this year was growth. We were fortunate to experience a lot of growth and opportunity during the pandemic, and we had increased the size of our team to meet that demand. As we got into 2023 it became clear that the slowdown was going to affect us all and we had to make some tough decisions to right-size our people costs. We know we’re not alone. We’re hearing the same story from a lot of our clients and prospects as well. So here are the elements we feel are most important to address as you manage your business and prepare to weather this slowdown in the economy.

Questions to ask yourself and your leadership

• What were the investments we made in our growth?
• What do we see that actual growth being?
• Are the size of your team and the growth projections aligned?
• If not, where can you make strategic cuts and still provide the level of service/ support/ delivery that your customers are accustomed to?

Businesses grappling with their growth and cost strategies need a thorough understanding of financials, coupled with the ability to critically assess assumptions. When it comes to making decisions about people, it’s always – well – personal. But with a clear eye and good data decisions about hiring or reducing the size of your staff can be made knowing that it is the right choice for your business going forward.

For businesses that are asset-heavy or equipment-heavy, or a combination thereof, the right-sizing discussion will be multi-layered. Really, as you look at ways to prepare for a slower economy the key is to understand your numbers and your trends and clearly define your goals based on that data. A strategic partnership with Signature Analytics provides that kind of guidance. We make sure our clients know their budget, forecast, cash flow projections and can right-size their companies based on those numbers.

Making Hard Decisions Easier

As a business owner, it’s not that hard to identify excess costs or call out underperforming team members. But having the data to support those assessments ensures that you’re making smart cuts, not just those that are most obvious.
For us, At Signature, we took a hard look at our people costs, real estate costs, technology costs, and other costs within our organization to determine which costs make sense, which are adding value to our company now, and which roles and activities we see adding value in the future.

Because we did a comprehensive cost assessment, in some cases, we didn’t cut costs, we increased them because we uncovered opportunities to take advantage of trends in the market that didn’t exist a year ago.

It’s not just about slashing roles and reducing people costs, there are nuances that go along with knowing your numbers. Understanding what your historical trends are, understanding the impact of expenses and investments and what they’ve made to your business is critical.

Accountability in Decision Making

At Signature Analytics, we know the value of having an accountability partner – someone who can challenge your assumptions. We act as a strategic partner for our clients to add a collaborative approach to decision-making. With an expert at your side, it’s easier to ensure the organization continually aligns with the changing market realities and doesn’t just rely on past successes.

Having an accountability partner or a person, either as a consultant or within your company who helps you challenge those assumptions is a vital role. The assumptions we made a year and a half ago, needed to be challenged. When we took the time ourselves to address our human capital costs and many other costs holistically, we decided some areas need to be cut, some teams, streamlined, some costs reduced and others increased.

Our CFO Business Advisory services help our clients have access to the kind of expertise you get from a full time CFO but at a fraction of the cost – and for a fraction of the time. Making smart and well thought out decisions that don’t have to be rolled back saves everyone time, money, and lost revenue.

Technology costs can be the secret drain of cash in any business.  The slow incremental (or sometimes rapid) rise of technology costs can occur under the radar of even the most vigilant CEO.  At Signature Analytics, we recently conducted a technology audit and discovered so opportunities to cut costs and improve efficiency all in one swift change of vendor. 

The Ever-Evolving Tech Landscape

There are so many options when it comes to software and technological tools. From Software as a Service (SaaS) solutions to the burgeoning field of Artificial Intelligence (AI), there is an ever-growing list of options. However, these services often come with incentives that make them appear more affordable in the first year or initial agreement, leading to costs that can quickly escalate as time goes on.

When we looked at our own technology expenses, we discovered that we had areas that were easy to trim back such as maintaining more ‘seats’ than needed, and areas where our contracts had jumped in cost upon renewal.  We know we’re not alone.  This happens to our clients all the time.  

Research and Negotiation

An essential step we took was a comprehensive review of our technological assets: which technologies were in use, who was using them, and what value they brought to the company. This process illuminated areas of over-payment and under-utilization, paving the way for cost-cutting measures.

Take some time to research the current market, you may find new platforms that offer greater functionality at a more cost-effective rate than your existing systems. Yes, switching takes time and effort.  But it also focuses your teams on their internal processes and for soem software requires a deep dive into data that may have become muddled over time.

Can’t find a better solution? Research offers a benchmark to bring to your current provider to start a renegotiation. By understanding the competitive landscape, you can approach current vendors and negotiate better pricing to get the best value for your investment.

Strategic Cost Evaluation

The key to reducing expenses is strategic trimming not across-the-board cost-cutting. When you understand your numbers, analyze cost trends, and determine the value driven by those expenses it becomes very clear where you’re overpaying and what services you can reduce or eliminate entirely.

When you reduce costs in one area it can officer an opportunity to invest in areas you may have been constrained in.  Reduced software costs and better systems might leave room for leadership coaching for middle management or an increased spend in marketing.  Or even that outsourced accounting team you always wanted to support your in-house accounting staff! 

It’s all about finding ways to increase efficiencies in cost structure and manage your business more effectively.

Technology is an essential aspect of any business, so it is critical to ensure it is providing value proportional to its cost. Regular review, market research, and strategic cost evaluation are vital to keep these expenses in check, ensuring they are both necessary operational costs and strategic investments driving your company forward.

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.

Improve 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.