This article is an extract from the book 'Everything you need to know about Xero Practice Manager'
Get a copy for your desk at www.linkedpractice.com
Client profitability
Client (and job) profit is one of the metrics we want to look at when reviewing the performance of our jobs and our clients. It’s important to understand whether the job was profitable or not. If a job or client is not profitable, we need to understand why. Here are some reasons:
- The engagement was underpriced
- The staff member is struggling to deliver that particular service within budget
- There was a variation that was not raised with the client.
Job profit is calculated by taking the total invoiced amount for the job and subtracting the total cost of the job. This sounds simple in theory, but in practice it opens up a rabbit hole. A rabbit hole that we are about to go down now.
Invoice total is easy to identify. It is the amount you invoiced for the job. The total cost, however, can be interpreted in many ways as it is driven by the base rates on the time entries. In XPM, we allocate each staff member a base rate. There are two schools of thought on this. You either enter this as the staff member's true cost, or you enter a burdened base rate. The true cost is their hourly rate we pay them. A burdened base rate is their hourly rate plus an overhead apportionment.
Let’s look at an example.
Say Jacob is on a $75,000 salary. This works out to be about $36 per hour, assuming a 40-hour work week. Jacob gets four weeks per year as paid time off, so his cost rate while working is $39 per hour. We could enter $39 per hour as his base rate in XPM as this is his direct cost per hour. So if Jacob spends 10 hours on a job, it costs the practice $390.
If we take the burdened base rate approach, we will apply an overhead rate to his base rate. We do that by taking the overheads of the business (excluding wages) and dividing that cost by each hour worked. If there are 10 full-time employees at Jacob’s practice, we would have 19,200 hours worked each year. If we had $400,000 of business overheads (excluding wages), we would divide the $400,000 by 19,200 to arrive at $20.80. Jacob’s burdened base rate would therefore be $39 + $20.80 = $59.80. So every hour Jacob works costs us $59.80.
When calculating burdened base rates, we typically do not adjust for projected non-productive time. This is because we end up in a situation where productivity begins to drive our cost so we have an ever-moving cost function. This phenomenon creates a variable in the base rate calculation, which begins to adjust all our other metrics. To keep things simple, our overhead base rate is overheads (excluding wages) divided by total time worked.
As you can see, the total cost we use in our profit calculation is not a hard and fast rule. We have two options: true cost or burdened cost. So which is better? It depends on how you interpret the information. Generally, it is better to look at staff performance against the true cost, and job performance against the burdened rate. This is because we want to know how staff perform against their true cost, whereas with jobs we want to know that we make enough money on them to pay both staff and overheads.
The trouble we run into is XPM only allows us to enter a single base rate, so which do we choose? That is totally your choice, but it is important you understand which method you have chosen when you are interpreting your reports.
Link Reporting gives you the ability to override the XPM base rates. Each staff member has their own direct cost rate for a month, and the organisation has its overhead rate for that month. When these are entered into Link Reporting, the cost calculations in both the staff and job reports will use the Link Reporting rates by default, rather than those entered into XPM. This allows you to report on your staff at a direct cost, and jobs on the burdened cost.
The other added benefit is Link Reporting allows you to backdate these base rates. So if you have not had them set up correctly in XPM, Link Reporting will retrospectively recalculate all staff and job performance based on the rates you enter for that month.
To sum up this section, job profit is the invoice total on the job, less the cost on the job. The invoice total is definitive, whereas the cost is more subjective. This subjectiveness of the cost means we need to interpret the profitability of our jobs whilst keeping in mind the method we have used. The ideal option is to use Link Reporting and split your base rates into direct cost and overhead cost. This allows you to report staff performance by direct cost, and job performance by the burdened cost.
Job profit is a great metric for seeing how our jobs and clients performed for the year, but it does not tell us the full story. Assuming we have our costing methods nailed down, let’s say we have one job that has a profit of $500 and the other has a profit of $300. Which job performed better? Your instinct is to say the job with a $500 profit, but we are not comparing apples with apples. The $500 profit could have been on a job that had a $9,500 cost and was billed $10,000. This is not a successful job. Whereas the job with a $300 profit could have been a $200 cost and was billed $500. This is a highly profitable job.
Where therefore need to also look at what the profit margin is. The profit margin is the profit divided by the revenue. Using the example above, the job with a $500 profit only had a 5% profit margin. We get this by dividing the profit of $500 by the total revenue of $10,000. The job with a $300 profit, on the other hand, had a profit margin of 60%. We need to be looking at both the profit and the profit margin to get a feel for how the job performed.
To report on job profit and profit margin in XPM, create a job report using the report builder.
Here is how it is built:
Report type: Job Report
Fields to display on report (in order):
- [Client] Client
- [Job] Job Summary
- [Job] Budget
- [Job] Actual Cost
- [Job] Billable
- [Job] Invoiced
- [Job] Profit
- [Job] Profit %
Criteria for the report:
- [Job] Completed Date: is on or after {the start date of period you wish to report on}
- [Job] Completed Date: is on or before {the end date of period you wish to report on}
Rows are: Grouped and subtotalled by the first field
It is a good idea to run this report on a monthly basis so you can review the jobs that were completed for the previous month. If you want to get more information on the job, open the job up, navigate to the ‘Financial’ tab and open the ‘Job Financial Summary’. Here you will get a breakdown of the job at a task and cost level.
Link Reporting’s Client Profitability report makes the analysis of client and job profitability far easier, as you have the option of sorting the report by profit or profit margin from high to low, so you can quickly see the clients that you need to investigate further. You can investigate these clients by expanding them to see the jobs that made up the figure, then expand these jobs to see the tasks and costs at a line item level. You can also click onto any number in the report to open up a new tab with the time sheet details. You can help your team succeed by providing them the information they need at www.linkreporting.com
Enjoy this article? Buy the book.
Need help setting up, fixing up, or getting up to speed on Xero Practice Manager?
We can help at www.linkedpractice.com
Comments
0 comments
Please sign in to leave a comment.