A Complete Guide to Better Profit and Performance for a Service Business

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A Complete Guide to Better Profit &
Performance in Your Service Business
Service based businesses can be the most difficult to manage and
profit from. Trying to manage people, jobs/work in progress and your
sales pipeline can be an absolute minefield. The best way to overcome
the issues is to have a clear understanding of what you?re selling and
what impacts your ability to be profitable.
Here is some information and an example for you to consider in line
with your own circumstances.
Assumptions:
Services firm
- Employs professionally trained/educated ?technical? staff
- Professional fees (revenue) are based on ?technician?s? time
(possibly some materials and/or disbursements included also)
- Competitive market place for like services
- Clients ?engage? to have services provided
- Many engagements take the form of ?fixed quote? involving a
?scope? of services to be provided (becoming more prevalent as
clients become more savvy and conscientious)
- Engagements may last from several days to several months,
depending on the ?scope?
- Quality client relationships are vital (ongoing engagements)
Some examples of service based businesses
- Accountants
- Solicitors
- Surveyors
- Contractors
- Allied health (occupational therapists etc)
- Architects
- Town planners
- Engineers (civil, environmental etc)
- IT consultants
- Other
Performance??
- How do these types of businesses quantify performance
levels?
- When someone mentions
their performance has
been good or bad, how
are they forming that
opinion (good or bad
relative to what)? Last
year?s performance (plus
a fudge factor)? The
owner?s required level of
drawings? Some other
arbitrary number?
- How can we consider performance in a non-arbitrary form? Is
there a way to get some ?relativity? into performance
considerations?
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The 3x Model
Most (if not all) services businesses should be able to apply this 3x
model in their business. Put simply, the 3x model is:
Revenue earned from charging technician?s time should be equal
to or greater than 3 times professional salaries paid.
For example:
Firm A pays salaries to its technical staff of $450,000. Revenue earned
by charging for services provided by these technicians should be at
least $1.35m (which is $450,000 x 3). This could be considered as the
revenue ?target? or budget for Firm A.
Practically, this idea can be tested with a simple real life case study:
Industry: IT consultancy (IT network services)
Technician salary: $60,000 pa (excl SG super)
Chargeable rate: $120 per hour (excl GST)
Hours at work pa: 52 weeks less 4 (annual leave) less 2 (public holidays)
less 1 (personal leave) x 40 hours per week = 1,800
Productivity expect: 80% (meaning 20% of time at work is spent on tasks that
are not billable)
The revenue equation is therefore:
Expected revenue from technician = 1,800 x 120 x 80%
= $172,800
Our 3x model suggests revenue should be 3 times salary, which equals
$60,000 x 3 = $180,000
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A similar sum can be completed for other business types also. Generally
it will resolve to the same 3x salaries (or similar).
The 3x model lays out the fundamental basis of viewing a business?s
income statement in a different way, as follows:
Revenue (income) $3x (3 times salaries)
Cost Of Goods $1x (professional salaries)
Gross profit $2x (66.7% gross margin)
Overheads $1x (for efficient firms)
Net operating profit $1x (profit target)
Any professional services business, that critically reviews their
performance using this 3x model, will find areas for improvement.
Once this has been done you can start to make changes. If done so in a
regular, consistent and accurate manner, it WILL improve their bottom
line!
Month Tech A
(Senior)
Tech B
(2IC)
Tech C
Revenue
23.4 14.5 15.2
COGS
(Salaries)
7.5 6.2 5.0
Gross Profit
15.0 8.3 10.2
Tech D All Techs
13.3 66.4
5.0 23.7
8.3 42.7
Gross
67.9% 57.2% 67.1% 62.4% 64.3%
3 x Mulitple
3.12 2.34 3.04 2.66 2.80
Overheads
26.4 (1.11x)
Net Profit
16.3 (0.69x)
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Some considerations...
Performance measurements utilising the 3x model should be done
using an ?isolationist? approach. That is, for each period being
measured (month; quarter etc.), the performance measurements
should be ?isolated? to the work completed by people during that
period only (to the extent that it is possible).
The major benefit in this, is that useful comparisons and analysis
come to light where you are comparing like for like. This sounds
simple enough and it is, except when the work done during the
specific period is not all billed in that period.
WIP ? It is important!
In a services business, WIP (Work in Progress) is simply the billable
hours worked up to a certain point in time, that have not at that point
been billed. It is an asset of the business and should be represented
as such on a business?s Balance Sheet.
The movement in the value of WIP from one period to the next is
accounted for on the Income Statement (normally as ?movement in
WIP?).
The ?ageing? of WIP should be under constant review. Dated WIP also
has a negative impact on a business?s liquidity (available cash), in
many cases, this can be substantial and will create financial stress for
a business if left unchecked.
Many services businesses give little regard to WIP. Understanding WIP
and the impact it can have on performance is critically important. To
assess performance during a period without understanding and
accounting for WIP, will lead to confusion as to the real picture.
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The 3x model ? WIP
As previously noted, the 3x model considers performance using an
isolationist approach. By way of example:
Technician A logs times during August of 160 hours. Of those hours:
- 115 are of a billable type
- 29 are non-billable (administrative type tasks)
- 16 are for leave taken
- From this base of billable type hours (115 hours):
- 85 hours have been invoiced generating revenue of $10,625 (at
an average hourly rate of $125/hour)
- 30 hours remain unbilled, becoming WIP as at the end of August
- At this point, the assumption is made that all of the billable hours
that are not yet invoiced (and the WIP) will be invoiced at the
technician?s standard hourly rate at some time in the future.
This is all we are able to do at this point.
The income for Technician A for this period therefore becomes:
Billable hours invoiced $ 10,625
WIP (future income) 29 x $130/hour $ 3,770
Total income Technician A ? August $ 14,395
The obvious next question is then ... what happens if the assumption
made regarding the invoicing of the WIP is incorrect ? and the amount
invoiced is less (or even possibly greater).
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If the assumption regarding the value of WIP once invoiced is proven
incorrect (which inevitably it is), the variance is both noted in the
current month AND an understanding as to why it was different than
that assumed is pursued.
The income for Technician A therefore becomes:
Billable hours invoiced $ 10,625
WIP (future income) 29x$130/hour $ 3,370
Write downs previous period?s WIP ($ 1,500)
Total income Technician A ? August $12,895
Even though the WIP write downs is for work completed in periods
prior to the specific period being reported. The invoicing of that work
defines the extent to which the assumptions made were accurate,
which can only be done at that time the work is invoiced. Whilst this
method may be difficult to understand initially, in practise it makes
good common sense.
The above monthly (or
whatever period) income
structure is completed for
each Technician.
Additionally, each
technician?s individual WIP is
listed and scrutinised
regularly.
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Other
Cost of Goods Sold (COGS) is simply the salaries paid to service
staff. In order to avoid payroll weekly/fortnightly and ?End Of
Month? timing issues, salaries are considered on a calculated basis
rather than a cash basis, as follows:
Weekdays in month x hours in workday x salary
hourly rate (+ any overtime paid during the month)
for each Technician
Overheads are calculated as all expenditure for the month less
COGS (from above). Whilst important in any business,
month-to-month outlays are less important than a 3?6 month
average, due to irregular frequency of certain suppliers.
If products are also bought and sold as part of providing services,
they are treated in the standard accounting way (income less
purchase). Products that accompany the provision of services are
generally secondary in generating returns.
Clearly, 3x model reporting will have different results than a typical
double-entry accounting/bookkeeping system e.g. MYOB, Xero,
Quickbooks). Over time, the total of all results should, however, be
very similar. In essence, one should be used for compliance, the
other (3x model) should be used for management. Inherently, there
is a substantial difference between these two business functions.
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Objective Analysis
During the ?conclude? phase of the review process, conclusions
about performance should be drawn based upon the objective
?Measure? phase.
Detail in any
conclusions is
important to ensure
any strategy
formulated (the next
step) is pragmatic.
Typical questions that
should be considered
in drawing conclusions
may include things
like:
- What was the revenue multiple (to service salaries) for the
firm as a whole?
- Which Technical staff were above the firm?s score and
conversely, below the firm?s score?
- What specifically were the reasons for differences between
individual technicians (productivity, write offs/downs,
quotation over-runs etc.)? (relative to targets across various
technicians).
- What was the overheads multiple? What was the 3 month
average of the overheads multiple? What specifically is
higher than had been expected?In respect to WIP, what
?dated? WIP is there (older than 3 months) (on a technician by
technician basis)? Why hasn?t this been invoiced prior?
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By way of example, the following are ?conclude? samples that have
come forward in real life situations:
Quoting systems are inadequate:
- Insufficient thought is given to preparing quotations in respect to
work required to complete the scope detailed.
- Lack of understanding/buy-in between those preparing
quotations and those doing the work. Ideally there should be
collaboration during the quoting process.
- Quoted projects are not ?de-briefed? sufficiently. There is no
after-the-fact analysis of what transpired relative to what was
anticipated/expected.
- Scoping of work required was inadequate. The client?s
expectations from the scope were different to ours.
Write offs/downs:
- Billable tasks are written off/down because of a perceived lack of
value provided by a technician (who works with technically
clever people every day providing what they may consider to be
?nothing special? to clients and struggle with the notion that it
may have any value to a client).
- Low time tasks are written off due to perceived lack of value
delivery (administrative responsibilities).
Productivity
- Technicians? billable hours, relative to their peers is inferior. This
is generally not due to laziness but some other systemic issue,
such as a lack of well-defined position descriptions.
- Expectations have not been clearly communicated.
The KEY notion of this form of review is ?constant improvement?.
Inherent in this, is ongoing review of strategies implemented prior.
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Conclusions from the Analysis
This phase of the process should also focus on any strategies that have
been implemented (presumably from previous periods? conclusions)
and should seek answers to questions such as:
- Did the implementation of the strategy go according to plan? If
not, why not? (A strategy that works exhibits behavioural change)
- Was the implementation done with support and enthusiasm from
the staff? If not, why not (did they understand the reasoning
behind the strategy)?
- Has the strategy worked? Is more time needed to determine if it
has worked or not?
- Should changes be made to the strategy in light of what has
occurred?
Action!
- Information without resultant action has NO value!!
- Based on the conclusions drawn, strategies should be formulated
that have clear action plans. Ideally, both the strategies, and the
reasons for the strategies, should be communicated to the staff
involved in implementing the strategy.
- The action plan should include defined parameters, including:
what, who, how much and when.
- Accountabilities for implementation should be clearly structured
and communicated.
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The last step, whilst the briefest to describe, may be the most
important step in the whole process:
Get experienced help!!
Most businesses benefit from someone external to review the
business critically and objectively. CFO On-Call Partner?s are
experienced in working with business owners & managers to improve
profitability, cash flow and business efficiencies. A CFO On-call
Partner can provide advice for your business on an as-needs or
part-time basis without the expense of employing someone full time.
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