KPIs We’re Using with Prof Services Firms

We’re asked by our ProServ customers two questions:

1. How profitable is my labor force?
2. When do I hire my next resource and how much do I pay them?

The answers to these questions come from how well you track and measure your labor force.  That data will help you continuously improve your firm’s profitability as well as show you when you’ll need to hire more people (hint: never before you need them!)

The data presents itself in the form of Key Performance Indicators (KPIs).  These are the most popular ones we are using to help our customers make their labor force more profitable:

1. Gross Profit (includes labor cost)
2. Utilization
3. Revenue per head
4. Revenue concentration
5. Monthly recurring revenue

Note: if you are not tracking your labor force hours, most of this article will not be relevant to you. Your firm should be tracking its hours. While not perfect, it is the best way to determine the profitability of your projects and customers. Without it, tracking and improving profitability is much more challenging.

Gross Profit

In the professional services industry, determining gross profit involves a clear understanding of both revenue and costs. 

Revenue is typically tracked per customer and represents the income generated from services rendered. Costs, on the other hand, can be categorized into two main components: labor costs and direct out-of-pocket expenses. 

• Labor costs are calculated by multiplying the employee's hourly rate by the number of hours worked on a specific customer project. 
• Direct out-of-pocket expenses include any costs incurred specifically for a customer, such as travel, materials, or software licenses. By accurately tracking these costs, firms can gain valuable insights into their profitability.

Calculating an employee’s hourly rate requires adding up the full costs of an employee: their wages, employer payroll taxes, and employer-paid benefits.  We call this the fully loaded labor cost. Calculate this per employee for a full year and divide by 2,080 hours (52 weeks * 40 hours per week). That’s your hourly rate.

Calculate some other hourly rates as well:

Revenue per hour = Total revenue from a project / total hours spent on the project

Out-of-pocket cost per hour = Total out-of-pocket costs / total hours spent on the project

With these numbers in hand, you can calculate your gross profit by customer:

Gross profit = Revenue - labor cost - out-of-pocket cost

You can divide each operator above by the number of hours spent on the job to determine your hourly rates.

Knowing your hourly rates is helpful because you can find ways to perform the labor at a less expensive hourly rate, boosting your profit margin.

Utilization

Utilization rate measures the efficiency of your workforce by comparing the number of hours spent on billable client work to the total number of available working hours. The formula for calculating the utilization rate is:  

Utilization Rate = (Billable Hours / Available Hours) x 100  

For example, if an employee has 40 available hours in a week and bills 30 hours to clients, their utilization rate would be 75%.  

While a higher utilization rate might seem desirable at first glance, it's crucial to find a balance. Overly high utilization can lead to employee burnout, decreased quality of work, and even higher turnover rates. On the other hand, low utilization suggests that resources are not being used effectively, and you’d be paying for employee's downtime.  

So, what is the "right" utilization rate? There's no magic number, as it varies depending on factors like the firm's size, service offerings, and industry benchmarks. However, a generally accepted range for professional services firms is between 70% and 80%.

This range allows for sufficient billable work while providing employees with time for non-billable activities like administrative tasks, professional development, and internal meetings. It's essential to regularly monitor and analyze utilization rates to ensure optimal productivity and employee well-being.

Revenue per Head

Revenue per head, also known as revenue per employee, is a crucial financial metric for professional services firms. It measures the efficiency and productivity of your workforce by calculating the average revenue generated per employee. The formula is straightforward:

Revenue per Head = Total Revenue / Total Number of Employees

This metric offers valuable insights into the firm's overall financial health and operational efficiency. A higher revenue per head generally indicates that the firm is effectively utilizing its human capital to generate income. 

While benchmarks can vary, revenue per head benchmarks can be correlated to a firm’s current lifecycle stage.  Research by Collective54, a mastermind community of boutique professional services providers, puts out the following guidelines:

1. Growth stage = $200,000 per head
2. Scale stage = $400,000 per head
3. Exit stage = $600,000 per head

These are general guidelines and should be used in consideration with your industry’s and company’s specific circumstances.

Revenue Concentration

Revenue concentration refers to the proportion of a company's total revenue that is generated from its top five clients. High revenue concentration can pose a significant risk to professional services firms, as over-reliance on a few key clients can lead to financial instability if those relationships deteriorate or if those clients experience their own business challenges. Imagine if one client, responsible for 40% of your revenue, suddenly decides to take their business elsewhere – the impact could be devastating.

That's why monitoring and managing revenue concentration is crucial, especially for growing firms. As Collective 54's data suggests, a growth-stage company should aim to have no more than 50% of its revenue coming from its top five clients. This allows for a more diversified income stream and reduces the risk associated with dependence on a few key accounts. As the company matures and scales, it should strive to further reduce this concentration to 40% or less and ultimately to 30% or less for those in the exit stage. By actively seeking new clients and expanding services to existing ones, professional services firms can create a more balanced and sustainable revenue portfolio, ensuring long-term stability and growth.

Monthly Recurring Revenue

Monthly recurring revenue (MRR) is the holy grail for many businesses, and professional services firms are no exception. Why? Because MRR provides a predictable and stable income stream, which is essential for sustainable growth. 

Instead of constantly chasing new projects and dealing with the feast-or-famine cycle that can plague project-based firms, those with MRR enjoy consistent cash flow that allows for better financial planning, investment in growth initiatives, and greater peace of mind. This steady income stream can also make the firm more attractive to investors and lenders.

However, building MRR in a professional services context can be challenging. It requires shifting from a project-based mindset to a service-based one, where offerings are standardized and packaged into recurring subscriptions or retainers. 

This often involves adopting fixed-cost pricing models, which can be difficult for firms accustomed to hourly billing. Successfully transitioning to an MRR model requires careful planning, clear communication with clients, and a commitment to delivering consistent value over the long term. But the rewards – predictable revenue, improved scalability, and enhanced financial stability – make it a worthwhile pursuit for professional services firms looking to thrive in a competitive landscape.

The Importance of Tracking KPIs

Tracking these KPIs is crucial for professional services firms as it provides insights into the overall financial health and operational efficiency of the business. By monitoring these metrics, firms can:

• Make informed decisions: Optimize profitability: Understanding labor costs, utilization rates, and revenue streams allows firms to identify areas for improvement and optimize profitability.
• Mitigate risks: Tracking revenue concentration helps firms identify and mitigate risks associated with over-reliance on a few key clients.
• Enhance employee well-being: Monitoring utilization rates helps firms strike a balance between productivity and employee well-being, preventing burnout and high turnover.
• Drive sustainable growth: By tracking these KPIs, firms can develop strategies for long-term sustainable growth, ensuring financial stability and a competitive edge.

To effectively track these KPIs, firms need to:

• Implement time-tracking systems: Accurate time tracking is essential for capturing billable hours, calculating labor costs, and analyzing utilization rates.
• Utilize financial management software: Robust financial software can help firms track revenue, expenses, and profitability, providing real-time insights into key metrics.
• Develop a data-driven culture: Encouraging a data-driven culture within the organization fosters a focus on continuous improvement and informed decision-making.

By investing in the necessary tools and processes, professional services firms can leverage the power of KPIs to drive profitability, optimize operations, and achieve sustainable growth.