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Objective Measures: Financial Performance

November 18, 2009 2 comments

I’m starting this series with financial metrics under the theory that financial statistics are the easiest, most objective things to track and report.   Financial performance metrics address the entire suite of measures related to consulting activities as measured by hours, revenue, billings and cost.   The focus for this discussion is using these metrics to judge individual consultant performance, not overall practice health – we’ll discuss the broader picture of practice health at another time.  Also, this is not intended to be an exhaustive list – I picked the measures that I consider MOST important to evaluate.

When considering financial metrics, three things are important – what do you measure and what do you do with the measurement?

What to Measure?

1. Utilization: 

This is a labor efficiency metric showing the total number of hours you billed as a percentage of the total available to be billed.  Three total available hour calculations are available to you:

Full Year:  Easy, its 2080 hrs per year (52 weeks * 40 hours).  However, using this as the denominator means that some people are okay at 88% ute (like consultants) and some are okay at 30% (like directors).  Hence, I don’t use this.

Net Planned NC:  This is 2080 – PTO – Study/Admin – Sick.  If each of those components is 80 hours, that leaves you about 1840 hrs available time or about 88% of the fully loaded hours.  I’d expect a consultant to bill this, but a PM engaged in selling or a director would not be able to.

1600 Rule:  This is a good thumbnail for a low intensity practice.  Basically, everyone is expected to charge 32 hours, 50 weeks per year and spend a little less than one day per week making contributions to the the company knowledge base, recruiting and doing administrative work.  Practically speaking, if you factor in sick time, you’d need to bill about 33 or 34 hours per week to stay in range.

I keep the use of the above pretty simple:  “Total Available” for consulting staff (sole contributors) is based on Net Planned NC (1840).  For PM’s, I use the 1600 rule.  Directors, and other team contributors in similar capacity, are at 10-20% of the Net Planned NC target.  Don’t forget to adjust the denominator for the Hire Date if the person was hired inside the year being measured.

The target goal for Ute, in my opinion, is always 100% of an individually set number of totally available hours.  95% is bad, 100% is good, over 100% is best. 

2. Realization:

This is a revenue efficiency metric showing the total revenue captured out of the total available to be captured, expressed as a percentage (Revenue Billed / Total Available Revenue expressed as a percentage).  Like ute, the denominator in the Realization calculation is critical.  Generally, it is Total Available Hours x Budget Rate By Position.  The last two words are critical – like ute, you want to target 100% as the performance standard, so the rate by which you multiply the hours should be the rate at which that position is intended to bill.  Associates may bill at $140; Directors at $210.  Both would use these individual rates to rack up the total available revenue number.  Its up to you if you want to measure realization using budget rates or avg rates for a prior period – I prefer budget, but I actually look at both.

And, like ute, don’t forget to take into account hire date for employees hired inside the year under analysis.

3. Gross Mark Up:

This is the ratio of total earnings to total revenue.  The calculation is pretty easy:  take the total YTD salary + total YTD bonuses and incentive payments / total YTD revenue billed.  The resulting ratio shows you the the gross markup on the consultant cost.  In general, a practice needs to be above 2.5 as a group (including mgt), so the gross markup at an individual level should probably be higher.

With that said, the markup is going to be different for different levels of skill set.  Someone 1 or 2 years out of school, being used as a sole contributor should be close to 5.  Someone 15 years in the business, who does significant selling work, helps mentor, adds significantly to the ability of the firm to excel, etc may be at or just slightly above breakeven.

How do you use the measures?

First, don’t manage these metrics in isolation.  Managing solely to ute gets you high billed hours but not necessarily good collectible hours or high realization (as an old co-worker of mine once explained to the VC run board of my then current employer: “Hell, if ya’ll want ute I’ll sell our time on eBay at $1 an hour”).

Second, always look at all of this for the billing week, then MTD, QTD and YTD. Make certain you isolate the trend (up, down, stable) rather than making decisions on a single billing period.  It doesn’t hurt to look at a rolling 6 week average to flatten a bad week.

Third, always look at ute and realization together.  I don’t have high ute.  However, I usually bill at or above $200 / hr.  So, I don’t need a ton of billed time to nail my realization target.

Fourth, review Gross Markup monthly or quarterly and always look at YTD numbers.  Any period shorter than a month starts to get misleading.  If you don’t pay incentives monthly or quarterly, you probably need to start building in accruals to the analysis or your numbers will be too low.

Finally, don’t make any decisions about people based on the above.  Read the next few posts in the series and make decisions based on both financial and cultural perspectives.

And, lastly, how do you accumulate all this detail information?  Business Intelligence tools like SSAS really help, especially when combined with ERP time billing systems.  I’ll do another post a little later detailing how my company does it today because I can fill pages about techniques for doing this right.  However, don’t let a desire to automate stop the measurement process – if you system isn’t perfect, its still better than nothing.

Next post: Objective Measures – Client Satisfaction

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