Calculating professional services profitability is a mix of art and science. In this post we discuss what that means, and importance of making sure you know ALL your costs and apply them properly to your profit calculations.
Are you sure your IT service group is operating profitably? Are you really sure?
The formula for profit is simple enough. Revenue minus costs. Since it's easy to total up all your revenue, the answer lies in how well you account for your costs.
So you may now be saying “Well, it’s easy to total your costs, too. We do it every quarter.” That means that you’ll only know if you’re profitable at the end of each quarter. How do you go to bed with a clear mind all the other nights? You can if you properly cost each hour that each of your service professionals bills to calculate profit on each service delivered each day. This requires knowing the cost of each professional’s hourly rate.
Paul Dippell from Service Excellence suggests that the easy way to calculate the cost of an hour of service is to take the service professional’s W-2 total compensation and multiply by 2.5. Divide that by 2080, the number of hours in a working year, and you arrive at your cost. An inaccurate cost. This is not something you can afford to estimate.
Fully Burdened Cost
It takes a little more accounting work to properly and accurately calculate your actual cost per hour of service for each of your service professionals. Since this does include their annualized compensation per hour the costs will vary for each of your people depending upon their level and salary. Their salary per hour forms the basic direct cost of their time.
Next you need to include the other additional indirect costs involved in having each person work for you. Some can be applied directly to each individual. A portion of other costs will need to be calculated and allocated to each worker. These costs can include:
- Health Insurance and employer contribution to other benefits such as 401(k), retirement, etc.
- Taxes, including employer contributions to payroll taxes, FICA, Medicare, state taxes and other
- Tools, equipment, and supplies
- Communications, including mobile internet and phone access
- Training, Seminars, & Manuals
- Subscriptions to services and publications
- Transportation & Lodging
- “Cost of Chaos” – some hidden costs including time spent in training, rework time, and one which will be discussed in more depth shortly, un-billed time
This is just a partial list. Your accountant can help you assemble the complete list for your business.
Taken all together, these costs will significantly exceed salary alone, but they do reflect your actual costs accurately. But wait, you’re not quite done.
Many think that utilization percentage is just a great key performance indicator for their sales effort. It is much more. It is a critical component of the cost calculation.
After totaling all the direct and indirect costs already discussed, we wind up with a “cost per hour” calculation. However, the total hourly cost presupposes we will recapture it with a total of approximately 8 hours per day or 2088 hours per year. That number of hours reflects 100% utilization which is altogether possible and discussed in another post on this blog.
50% utilization means you only have half as many hours to capture revenue to offset those costs. This instantly doubles your costs.
Let’s say that you only sell half of the available billable hours for one of your people. This 50% utilization means you only have half as many hours to capture revenue to offset those costs. This instantly doubles your cost. Divide the number of hours utilized and billed into the total billable hours available to arrive at your actual, fully burdened cost. Finally subtract that from revenue to arrive at profit.
Impact of On-Demand IT Professionals
The TDX Talent Pool is a community of IT professionals with a range of proven technical skills, all available on-demand for you to engage easily working with Techadox.
Calculating your cost is far, far simpler when you use on-demand professionals. The TDX platform provides a specific cost-per-hour. For larger engagements you can negotiate and agree upon that cost per hour in advance. That is your fully burdened cost per hour for that person’s services. Techadox takes care of the logistic operations including payroll and administration, right from your Techadox account.
To learn more about how to make your cost calculations simple and gain access to a world of highly-skilled IT professionals available to service your customers, simply contact Techadox today at www.techadox.com.
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