Professional services firms come in all shapes, sizes, and types – law, accounting, architecture, engineering, field services, janitorial, specialized consulting, and the list goes on. While each is decidedly different, the common denominator connecting them all is providing services – work being performed for a fee.
Professional services firms use all sorts of fee structures as well – hourly, time and materials, fixed price, commission, milestone-based, and more. Regardless of how services are billed, if the main thrust of the business is providing a labor-based service, six common operating metrics apply in any industry. Let’s look at each of them.
This metric shows the amount of revenue earned for every hour employees were paid to complete client work. When professional services firms perform a significant volume of unbilled or discounted client work, this metric can shine a light on it. Highly efficient work on big fixed-based projects is also illuminated by the revenue per hour metric.
Net Direct Labor Multiplier is calculated as Revenue divided by Direct Labor dollars. This metric is similar to Revenue Per Hour but specifically highlights the relationship between Revenue and Direct Labor cost. In this calculation, Direct Labor includes cash compensation but not the cost of benefits. For this and all metrics involving Labor cost, annual or discretionary bonuses are typically excluded.
The Net Payroll Multiplier or “Revenue Factor” is calculated as Revenue divided by Total Direct Labor dollars (again cash compensation, not benefits). This metric shows the relationship between revenue and total workforce cash compensation and gives another view into a professional service firm’s efficiency.
Utilization is calculated by dividing the total number of hours employees worked on billable projects (Direct Labor) by their total hours available (Total Labor). The purpose of the Utilization metric is to provide a measure of labor spent on client work vs. administrative or non-client work. Utilization is commonly expressed as a percentage of labor dollars and can also be expressed as a percentage of hours worked. Each approach can provide a different insight.
Administrative Staff to Total Staff is calculated using full-time equivalent (FTE) employees. This metric provides a view of the relationship between employees who are mostly non-billable to those whose primary function relates to billable client service. Another variant of this metric is the Field-to-Office ratio which provides a view of people performing client work relative to those performing other functions.
Overhead Rate is calculated as Total Operating Expenses (excluding Direct Labor) divided by Direct Labor. This metric shows the relationship between the Direct Labor cost of servicing clients and everything else that supports it (i.e., Overhead). Overhead includes the truckload of other expenses that a professional services firm incurs – indirect labor, employee benefits, occupancy, professional services, training, insurance, IT costs, and more.
Most charts of accounts contain the level of detail and data needed for calculating these operating metrics with one notable exception – the split between Direct and Indirect Labor. To capture Direct Labor, most firms need some sort of time-tracking system. Because most people view filling out timesheets with the same disdain as submitting expense reports, it can require a big cultural shift to get employees to complete this task consistently. Once there, a mechanism to translate Direct Labor Hours into Direct Labor Dollars and get that information into the general ledger is needed.
There are many other important metrics beyond those detailed here – days sales outstanding on Accounts Receivable, balance sheet leverage, employee benefits to total labor, and countless more. All have their place. However, Revenue per Hour, Net Direct Labor Multiplier, Revenue Factor, Utilization, Administrative Staff to Total Staff, and Overhead Rate all focus on the operating efficiency of a leveraged labor business model. They can be trended over time, compared to budget, and often benchmarked against industry comps.
Discount a big job… see what that does. Let Ted spend a lot of time on a feel-good internal project in favor of doing client work… see what that does. Land a big job and pull those employees off the bench… see what it does. In due time, you will develop a strong sense of how different decisions and practices impact these metrics and how, in turn, these metrics impact profitability.
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