Project profitability is a crucial metric for firms to gauge the profitability of their services. By employing project profitability analysis, firms can assess the efficiency of their operations and determine the value of their projects in terms of the resources invested. This information is essential for making informed decisions regarding project prioritization and determining the feasibility of undertaking new projects.
Defining & Understanding Project Profitability
What is project profitability? Project profitability is a financial measurement of the potential financial gain a project can make for a firm. It considers the revenue generated and the cost associated with delivering a project.
However, when undergoing project profitability analysis, it’s important not to focus solely on revenue. All revenue is not created equally. If the cost to deliver a project exceeds the revenue it generates, this can negatively impact a firm’s overall profitability.
Why should a firm care about project profitability? When the primary source of profit is generated from project work, project profit margins have a significant impact on firm profitability. It is the fuel for growth and sustainability. Project profitability is one of many factors a firm can use when internally ranking and prioritizing the projects and clients they want to work with. Understanding a project’s profitability can help a firm determine what type of projects they wish to pursue and assist in estimating future projects to achieve target profitability.
Calculating Project Profitability: Formulas for Projected Gross Profit
While there are many ways to track and calculate project profitability, related formulas are commonly expressed in terms of gross profit and gross profit margin.
Project Gross Profit is the amount of revenue remaining after accounting for the costs of earning that revenue. This would be calculated with the following formula:
- Project Gross Profit = Project Revenue – Project Expenses (direct resource costs + other direct costs).
Project Gross Profit Margin is the percentage of profit compared to the total revenue earned. This would be calculated with the following formula:
- Project Gross Profit Margin = Project Gross Profit / Project Revenue.
Factors Affecting Project Profitability Analysis
Factors such as estimation, project management, execution, pricing, team composition, rework, discounts, and timing all influence project profitability. Let’s break down some of these key levers:
Pricing & Engagement Models
Setting billable rates may seem straightforward, but if a firm isn’t regularly monitoring resource costs, its billable rates could quickly fall behind, making it almost impossible to have a desirable project profit margin.
Projects can be structured in various ways – fixed price, milestone-based, time and materials, or cost plus. Time and materials can have steady project profit margins if the bill rates are set appropriately. Many firms may choose the time and materials route when there are many unknowns. Fixed or milestone-based projects work best with well-defined and clear deliverables.
Team Composition
Although it may seem cost-effective to assign less experienced team members to a project to increase revenue, this strategy may be more expensive in the long run. While it may reduce initial costs, it can lead to additional expenses, such as redoing work. On the other hand, utilizing more experienced personnel can result in a higher cost to deliver the same services that someone with less experience could provide. Team composition should be structured to ensure the successful delivery of the project while also maximizing profitability.
Project Estimation
If a project is not accurately estimated, the cost associated with successfully delivering the project could exceed expectations and result in lower-than-desired project profitability. Therefore, ensuring a firm has a consistent and accurate process to estimate projects is essential.
Scope Creep
If proper project management is not adequately implemented, scope creep can increase the cost of delivering a project successfully. That is why it’s important to define project scope properly and continually track changes in scope through a series of change orders that detail the changes in scope and the fees associated with those changes.
Other Considerations
Continuous monitoring and analysis of project profitability is crucial for firms, as it can significantly impact overall net profit margins. Nonetheless, relying solely on project profitability can provide an incomplete assessment of the firm’s financial health. Additional factors such as overhead costs, utilization rate, and strategic discounts must be evaluated when undergoing project profitability analysis. To maintain high projected gross profit, effective resource management, quality project management, high billable utilization, and delivering quality services are essential.
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Jacob Stone
