What is project profitability? How do you know if your project is profitable? Learn the answers to the hardest questions in our complete guide.
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Do you know if your last project was profitable, and by how much?
Truth be told: only 9% of agencies think that their projects are profitable. In contrast, a whopping majority of 90 to 95% of agencies say their project profitability needs work.
Essentially, the problem lies in a poor understanding of profitability analysis in project management. After all, it’s only when you know the nuts and bolts of calculating project profit, you can focus on improving it.
So, in this guide, learn exactly what profitability is, how to measure profitability, and how you can take project profit from zero to hero.
Project profitability is the yield or profit that each project brings in for your agency after accounting for all costs.
On the surface, it may seem that a project is profitable when your client pays more money. Factoring in its labour costs, and the time and resources that go into it might reveal an entirely different picture though.
Hence, a better way to correctly understand project profitability analysis in project management is to look at what it’s not. So let’s start there:
Sure, bringing in projects on time is essential to the success of any agency. But it has nothing to do with project profitability. In fact, the hours logged in to complete these projects may be too high. This can reduce your profit margin significantly.
In an effort to grow quickly, some companies can’t see the forest for the trees, so they take on more projects without thinking much about their ROI.
Having a lot of projects with slim margins in your pipeline, however, doesn’t mean you’re driving enough profit unless you’re bringing in all profitable projects.
Finally, working hard and driving results for your clients also doesn't mean you're reaping a lot of profit. Instead, a project is more profitable when you’re putting in less work in less time but delivering significant value to clients.
That is: the quicker you complete the project and the less work it takes, the more time and resources you’ve left to take on other projects. But, of course, you can’t say this for all the work in your pipeline.
Be mindful though: profit isn’t the money coming in as clients pay you for their running projects. Instead, it’s the money the business earns after completing a project —post factoring in resource utilization (people, equipment, laptops, tools, etc.).
So profit is what’s left with you after subtracting the production costs from your billing.
Let’s break this down with one project profitability example.
Say, if a project brings in $1,000 and it takes you $650 to complete it, your profit is $350. Simple, isn’t it?
One thing though: not all projects bring in the same profit even if they’re priced similarly. In fact, a high-paying project doesn’t necessarily mean it’s profitable. So it’s essential you compare project profitability to prioritise clients accordingly.
But how can you compare profitability for one project against another? Use profit margins.
Profit margins aren’t anything technical. Instead, they're a way of expressing how much money you can keep out of every $1 you earn. Put this way, the greater the profit margin, the more money you’re left with at the end.
To calculate profit margin, use this formula:
Total project cost - total expenses / total project cost x 100
If you’ve already calculated the profit, simply use this formula:
Project profit / total project cost x 100
So, for the example above, the margin is 35%.
Here’s a deeper dive into how to increase profit margins on projects.
Unsure how to track numbers for each project? Start with our easy guide on project accounting. Then, choose from these project accounting tools to get things up and running.
Now that we’ve briefly looked at the meaning of project profitability, let’s see why exactly you need to bother calculating it.
In a nutshell, project profitability in project management helps agencies:
"Most professional service organizations have operational profit margins of 25-40 percent," according to Inc, implying that 25 to 40 cents of every dollar made goes to the bottom line. Businesses with lower overhead expenses have bigger profit margins than those with higher operational costs. This is because more money gets to the bottom line rather than merely supporting corporate overhead.
Three key pointers here:
1. Evaluate your project’s profit and margin (not just the budget)
Profit and profit margin will help you understand what you’ve made post delivering the work.
2. Don’t just do it at the end. It’s a lost opportunity.
Analyzing project profitability when you wrap up a project gives you good insights into the sum you’ve earned. It also leaves you with solid takeaways on what to do and what not to do in future projects as you land new clients.
But here’s the thing: if you don’t estimate and track project profitability from the first project itself, you’ll end up losing profit that you could’ve made.
The right thing to do here? Every quarter, think about the profit margin you want to achieve — set a target. Then, as you bring on a new project, estimate the profit it brings. This way, you’ll be well on track to meeting your profit expectation.
3. Budget for profitability from the start, then track as you go.
Track everything that goes into each project. This includes tracking the hours that go into its production as well as how those hours translate into costs.
You’ll also want to track the actual costs against what you originally planned. This helps you in two ways. One, it saves the estimated project profitability from going off track. And two, if you end up with more profit than estimated, you can learn how to better forecast profitability.
So you now have a rundown of what project profitability is, what it’s not, and how and when to calculate it.
Moving forward, let’s walk you through the meatiest part: how to improve project profitability.
There are three fundamental ways to grow profitability:
Of these, increasing your pricing and costs are pretty straightforward ways to improve project profitability. Utilisation or schedule management, on the other hand, is a less obvious, but powerful lever you can pull.
Here are the details:
You’ve got the following options:
It’s possible you’re undercharging for the value you’re providing to your clients. Naturally, this means your first best option to improve profitability is to charge more.
So how can you tell if you’re undercharging?
Begin with a competitor analysis to identify what others are charging in your comparison. Just be sure to look at the value they’re promising clients. And to understand how much of that promised value competitors' are delivering, go through their client reviews and customer success stories.
If you find you’re selling yourself short, increase your rates right away.
And don’t be afraid to charge your existing clients more. In fact, 50-60% of projects come from regular clients. These are people who already realise the value you’re driving for their business. So, if nothing else, you can put up rates to make up for inflation.
Where discounting is a good strategy for attracting clients, you can’t go about offering them without first evaluating how the freebie or discount impacts your profitability.
Once you understand the impact, assess if it’s worth offering.
It’s also useful to re-evaluate your payment model.
Of all the pricing models you can implement, fixed price work is the easiest to execute. It’s also easy to estimate, quickest to calculate, and effortless to share with clients.
However, it’s only best for projects you’ve a strong grip on, have a template-based execution plan, and a really well-defined project scope.
For other big projects with extensive work scope, a fixed price would likely mean you end up investing more than what you make in profit.
2020’s SPI research found that typically, time and materials-based projects often yield the best margins. According to the survey, IT Consultancies produced the highest time and materials margins of 38.7%, compared to 36.9% for fixed price models. The time & material model is less hazardous than a set price commitment since it assumes that the project's cost is based on real time spent and an hourly rate.
Another advantage is that your teams will be more adaptable to changing requirements because they won't have to nail down and plan all of the work ahead of time. When it comes to your financial strategy, paying for completed labor might imply two things: less uncertainty and more money saved.
If you find most of your projects are better charged using the fixed price model, make sure you share a solid statement of work (SOW) and a clear contract.
The main aim here is to ensure you clearly document what’s included in the pricing (including what’s not) to prevent scope creep. It also helps prevent misunderstandings and sets the right client expectations – all while saving you from going over budget.
Pro tip: Add a clause in your contract that explains the extra charges for work that goes beyond the agreed project scope.
Lastly, if possible break big projects into smaller ones. Why? Because not only are they easy to manage, but they also make it easy for you to keep everything including the profit on track.
Plus, you enjoy the opportunity to review progress and profit. This way, you can adjust things on the go instead of realising how over budget you’ve gone after the project completes.
Try these to drive profitability:
Review your overhead cost such as the rent. And ask yourself if all of these operating expenses are really needed or they can be reduced. For example, is it necessary to pay top dollar in rent or can you look for a more budget-friendly office space?
This saves you from the expenses of hiring full-time employees. So you can outsource some of the project work such as a consultant hiring a virtual assistant for admin work.
Or, you can outsource some non-billable work. Example: get an external company for accounting rather than hire an accountant depending on your business size.
Not all tasks need expertise that expensive seniors bring in. So another effective way to improve project profitability is to get seniors to work only on tasks that need their utmost attention. For the rest, assign work to juniors or intermediates who are often just as good for the work that’s needed.
To reiterate, track costs – not just the hours of work that go into a project.
To this end, use this 3-step framework: tract → detect → act. That is, track the amount of work, time, and resources that go into an individual project. Next, determine where things aren’t going as planned. Finally, take a remedial step to safeguard your profit.
Last but not least, create a streamlined workflow for your processes. It helps both save your time and identify inefficient tasks to eliminate too.
Not to mention, having defined processes assists in finding potential areas for improvement. All this contributes to better project efficiency and subsequent profitability.
This is a pretty smart way to improve project profitability.
Before you put it to work though, here’s some much-needed context around the valleys and mountains of services-based business workflow:
The goal? To optimize resources by scheduling projects in a way that all employees are working their billable hours.
In contrast, a lack of thoughtful scheduling means people sitting on the bench are eating up your profit.
Similarly, a heavy workload season would mean that either employees have to work overtime or you have to outsource work. Again, both of these negatively impact the revenue goals you plan for.
So here’s how to schedule in a way that there’s a steady amount of work coming that constantly keeps everyone busy on billable work:
Share it with your sales team. This allows them to see if you are already full as well as where there’s some work capacity available. Such visibility, in turn, ensures they don’t oversell and look for additional work that fits in the pipeline without killing profit.
Map out all the work that’s coming up so you can get an eagle-eye view on what needs work and plan accordingly.
This helps you see how much of your staff is available for work. It also means that you’re in a better position to offer discounted pricing by making the most of the people on the bench.
Here’s more on how you can manage workload better and the workload management tools you’ll need.
Put simply, take on smarter resource allocation. For example, if there’s a resource conflict between two projects, review which is a more profitable project and allocate resources accordingly.
To recap, profitability analysis in project management is critical as it contributes significantly to your small business success and decision making.
So here’s what you need to do:
