Want to raise your profit margins? Take a look at your recovery rates
In the professional services industry, one of the key metrics for measuring business success is profit. If your business is making a profit then all is well, or is it?
Have you looked at how much profit you could make or should have made?
While making a profit is good, fattening up the bottom line is better. There are a number of strategies a business can employ to improve its profit margins. Most commonly, business owners are recommended to examine and make changes to how they price and sell their services, and how they plan and steer incoming and existing work.
One factor that is often overlooked is how good the business is at turning hours into billable hours.
Recovery rates are a business metric that look at just that — they measure what percentage of a team’s billable time can actually be billed to the client, or in this case, time that can be “recovered”.
So, what are recovery rates, how can you improve them, and what factors contribute to them?
Let’s talk about recovery rates
The recovery rate is calculated by dividing the hours you billed to your client by your team’s billable utilization (the hours that were logged against a billable project) and is expressed as a percentage.
Recovery Rate = (Billed Hours) / (Billable Utilization)
Here’s an example. Your web development team adds a new feature to your client’s website, it takes them a total of 120 hours to complete the work. However, the project was budgeted and billed to your client at $10,000 based on 100 hours at $100/hour. When you divide the 100 hours you billed by the 120 hours your team logged, you get a recovery rate of 80%. (100 / 120 = 0.8 = 80%)
In addition to looking only at the recovery rate, you can bubble up the cost associated with the write-off. In this example your business lost $2,000.
Why do write-offs occur?
Most commonly, write-offs are a result of a team taking longer to complete work than was originally quoted or when fee discounts are given. It might take longer to complete the work than anticipated because of:
- Fixed-price projects. You agreed on a fixed price project, based on a fixed amount of hours. Your team took longer than the quoted hours to complete the work but you are contractually bound to stick to your agreement.
- Retainers. Retainers are essentially mini fixed price projects. You agree with your client on a number of hours per month that your team will use to work on maintenance tasks and small changes. Occasionally, these tasks may take longer leading to overruns.
- Mistakes. Your team made a mistake and needed to re-do some of the work. You decided not to pass on the hours to the client that were spent to rectify the problem.
- An inexperienced team. The work was completed by a junior staff member and took longer because it involved upskilling and training (which you don’t want to pass on to the client).
- Strategic projects. You’ve taken on a project that’s not within your core competencies but it’s an area that you want to break into. There’s a lot of initial research involved for you, which you don’t want to pass on to the client.
- Scope creep, changes and rework. Your client requests additions and changes to what was originally agreed upon and you’re having a hard time pushing back because your contract doesn’t clearly stipulate how to deal with these types of changes.
- Overtime. Your team is working on a project with a fixed deadline and needed to work overtime to get the project done on time. While you can bill the client for the hours your team put in, you didn’t agree on higher overtime rates. As a result, you end up with a lower revenue because of increased labour costs during overtime.
But wait, there’s more.
Generally, recovery rates are measured by the billable utilization for a specific person, project or the organization as a whole. Besides a project taking longer to complete than anticipated, there can be additional hidden write-offs further up or down the line.
If we take our first example with the $2000 write-off and expand on it to show the actual time worked and the time paid, we will see a greater discrepancy with an additional $2000 loss resulting from differences between the time worked and time recorded, and time billed and time paid. This results in a total $4000 write off, 30% less of what you should have been paid if you had a higher recovery rate!
Time worked vs. time recorded
When looking a time worked and time recorded, write-offs are very difficult to spot and measure. Most commonly they occur due to sloppy time-keeping practices or an employee not wanting to record hours they actually worked because of inexperience, competition with other team members or fear of “looking bad”.
To keep the gap between time worked and time recorded at a minimum, make sure your team records their hours at the end of the day while they can still remember what they did.
Build a work culture of trust and mutual respect. Remind your employees why correct time keeping is important for the overall health of the business and encourage them to speak up and ask for help when needed.
Time billed vs. time paid
Once you’ve reconciled your team’s hours and sent off the bill, there are times when your client might disagree with the billed work. This can be for many reasons, but often is a case of unmet milestones and expectations. Clients are known then to ask for hours to be chopped off the bill. If you decide to give a 10% discount to smooth over the billing, it results in an additional write off. If we use our example from above, this 10% discount would give a $1000 write-off, totalling $4000 in write-offs.
Getting around write-offs at this level goes back to setting clear expectations up front and establishing solid communication channels and regular check-ins with your client.
Measure those recovery rates
You deserve to be paid for the work you and your team do, so start measuring your recovery rates today and review your projects regularly. Look at projects with poor recovery rates, analyse where things went wrong and come up with a plan on how to minimize revenue shortfalls in the future. Likewise, take a look at your projects with great recovery rates and see how you can apply what went well to all your projects across the entire organization.
Originally published at http://blog.runn.io
