The 7 financial KPIs you need to know as a professional services business leader
A carefully thought-out framework of KPIs is critical for running a successful and profitable professional services organization. We give you a list of 7 essential KPIs you need to keep your financials on track.
So, are you running a healthy, profitable professional services organization (PSO)?
When the year is over, most of us will know after we settle the accounts and review our profits and losses.
But while the P&L analysis is essential for any business, when you are in the people-powered professional services industry, there’s a specific set of KPIs you need to keep an eye on profitability throughout the year.
This article gives the KPIs with the highest impact on your business finances that you need to run a successful – and profitable - professional services business or embedded PSO.
The 7 KPIs crucial to any PSO's finances
Through working with hundreds of PSOs (professional services organizations), we have identified the most common 7 KPIs with the highest impact on your business finances.
While overall revenue and profit figures are undoubtedly relevant for any business, you won't find them in this list.
Instead, we have included operational KPIs with direct financial impact, as these are the nuts and bolts you can tweak to tune your bottom line.
Time tracking is the foundation for any PSO's operational KPIs.
Learn more about TimeLog time tracking and try it for free today.
We have also included what you should be cautious about when using these KPIs as a management tool and their formulas.
So, let's get started. This first one is an oldie but goldie.
1 - Billability % (or billable utilization %)
This KPI tells you how much of your consultants' time you can bill your clients.
While some PSOs primarily look at their consultants' general utilization %, it is not the same, as billability % replaces productive time with billable time.
You might say that you shift focus from whether your consultants are busy to whether their time is, in fact, profitable.
For instance, a consultant might increase his or her utilization % working on a client project. But if he or she puts in more time on the project than you can bill the client, the billable utilization drops.
It's essential to keep track of this KPI, as this KPI is directly related to your consultants' profitability.
On time and material agreements, this KPI is easy to track. For these agreements, the billability % is 1-1, equivalent to what you can invoice the client relative to your total working time.
On fixed-price or retainers, you need to use your budgeted hours for the calculation.
Formula for billability %:
Billability % = Total working time / time that can be invoiced * 100
Caution:
As with utilization %, a narrow focus on billability % can lead your consultants to neglect important but not-billable tasks. Like competency development, project evaluation, team building, etc.
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2 + 3 - Average hourly rate / realized hourly rate
If you want to know what your consultants' time is worth, there's no getting around the average hourly rate.
If you mainly deal in time & material projects, then this metric is straightforward. It's simply the rate you charge your client by the hour.
However, even though many PSOs use this metric, it should only be indicative – not as a measure of how profitable your consultants are. Often, many hours are written down, so the rate does not reflect your actual work cost.
Also, it does not reveal much about the profitability of fixed-price projects where PSOs often pour in much extra time to get the job done.
For this, you should look at the realized hourly rate. The realized hourly rate will tell you the actual profitability of each hour of your employees' time on any given project or client.
Formulas:
Realized hourly rate/project = (Revenue made from project – project cost) / hours worked on project
Realized hourly rate/employee = (Revenue made from work – all associated cost + salary) / normal working time
Caution:
None.
What is the professional services industry’s average realized hourly rate?
4 - Under/over coverage on projected hourly rate
This metric is handy for measuring performance on projects with a high repetition rate and a high level of experience and predictability.
The KPI measures how far below or above you are compared to a fixed hourly rate target.
Especially for businesses operating in red ocean markets with narrow profit margins, this is useful to constantly tune your business towards maximizing profitability within the parameters of your service.
It often excels in revealing hidden complexities with agreements with clients on seemingly straightforward services.
Examples of industries where this metric is highly relevant include accounting, continuous IT services and marketing agencies that focus on optimization work.
Formula:
Under/over coverage % = (Realized hourly rate / target hourly rate) *100
Caution:
Even though it is always relevant to set hourly rate targets, this metric is usually unsuitable for businesses with very heterogeneous project types and pricing.
If you incorporate carefully thought-out KPIs from your junior consultants to the board, your sensors are in place. Then you can detect signs of a shift in the market long before it turns into a catastrophe and your customers leave.Read the article: 3 reasons to build your growth strategy on processes and KPI
5 - Revenue per employee/consultant
This metric reveals whether your business is overstaffed, understaffed or right on target compared to the revenue you generate.
Typically, businesses both measure this per employee (counting in all support functions) as well as per consultant.
Whereas the revenue per consultant will tell you the realized value of your product (your consultants' time and expertise), revenue per employee lets you know if you have the right balance between supportive staff and your "moneymakers".
Formula:
Revenue per employee/consultant = total revenue / number of employees/consultants
Caution:
Businesses focusing too much on this KPI might not adequately consider what supportive functions you need to run an efficient and profitable company.
From a strictly financial perspective, it can be tempting to optimize towards a very lean organization based on this KPI. But take it too far, and you risk overloading consultants with administrative work otherwise being done by support staff, thus eroding your consultants' value.
6 - Optimal hourly rate
Being competitive in the PSO market is just as important as being profitable. If you're not competitive, you will lose in the long run.
Finding the optimal hourly rate to charge your clients is key to competitiveness.
That being said, your consultants also need to be profitable.
To find the optimal hourly rate, you need to balance factors such as the profit margin you can charge and still be competitive, your cost, your consultants' standard working time and your targeted billability %.
The formula below strictly focuses on the hourly rate based on targeted profitability and the consultants' capacity limits.
If the formula doesn't add up after your factor in the competitiveness of your hourly rate, you might need to consider the value of the service you are providing or your cost level.
Formula:
Optimal hourly rate = ((Consultant cost + overhead + targeted profit margin) / yearly consultant norm time) / targeted billability %
Caution:
As the formula below is purely based on factors within your PSO, you need to test it against the market. What are your competitors charging? How unique is your service? What are clients willing to pay?
7 - Client profitability %
Are your largest clients also the ones that yield the highest profit margins?
If you are like most companies, your largest clients probably receive most of your attention and effort. But even though they bring in a lot of revenue – they also cost a lot in terms of hours spent.
Does this show on your bottom line?
Measuring client profitability % gives you perspective on the relationship between cost and revenue on any given client.
In short, which clients yield the highest profit margins – and which are simply draining your resources?
Mapping out the most profitable customers or types of customers is crucial for developing a growing PSO with a strong bottom line.
Formula:
Client profitability % = ((revenue from customer / (hours worked for customer * internal consultant hourly rate)) - 1) * 100
Caution:
There can be a lot of reasons to maintain a good relationship with high-profile clients even though their profitability % is low (or even negative). Some logo clients are great for references and can nudge your organization's performance.
On the other hand, large – and very profitable – clients often have exceedingly high demands that can challenge your general company strategy, especially if your company is small.
The question is; Are the profits from any one client worth derailing your company strategy in the long run?
Finance should only be part of your KPI matrix
The above 7 KPIs are just a few within the vast measurement possibilities available to PSOs today.
Only you and your team can decide what is right for your business.
Being profitable is important. However, measuring softer KPIs – for instance, employee and client satisfaction, confidence in leadership and colleagues or % of referential clients could be just as crucial for your business.
In an industry where competition for clients and consultants is fierce, many factors will impact how well your business is fairing. Not just the ones that are affecting your finances directly.
Get an overview of your financially related KPIs
If you want to start measuring financially related KPIs, you can test TimeLog for 30 days right here.
TimeLog is a modern PSA solution with a strong focus on financial project management that lets you keep track of consultants', projects' and clients' profitability.
You can also book a 30-minute meeting with us to discuss what KPIs could be vital for your business and how TimeLog can help you reach your goals.
