If you want to improve the effectiveness and sustainability of your project-based business, there are several strategies you can consider:
– One option is to focus on the most profitable customers and let go of those with lower margins.
– Another approach is to reduce your indirect costs.
To implement these strategies effectively, it’s crucial to have a clear understanding of your company’s financial performance. This involves creating a profit and loss (P&L) report for the entire company, as well as individual P&L reports for each project and task.
In this article, we’ll analyse employee productivity rates to determine which part of their salary that can be considered as indirect costs and how it impacts your P&L.
Let’s explore some examples of these strategies in greater detail to understand how to implement them in your project business.
Key things to control your P&L — What are indirect and direct costs? — Employee productivity rate Automating a profit/loss (P&L) report in practice — Expected result & Tools that we use — Collecting Worklogs — Convert collected work logs into money — Deducting "work log money" from the salary — A real life example Conclusion
To control your profit and loss (P&L) in the context of employee effectiveness, you will need to take the following actions:
– Regularly collect data on the productivity rate (worklogs) for each employee.
– Distinguish between indirect and direct costs.
Direct costs are expenses associated with employee activities that are directly tied to the products or services sold to the customer. As mentioned earlier, this article focuses on project-based businesses where employees produce intellectual work that is difficult to measure physically. For example, in a legal service, direct costs would include the salaries of your lawyers, while in an accounting firm, direct costs would encompass expenses incurred for your accountants who work on client tasks.
Indirect costs are expenses on employees whose activities are not sold directly to customers. For example, if you are an outsource IT development firm, such employees may include lawyers, accountants, and marketers. You do not sell their activities to your clients, but you pay them a salary every month.
Would you prefer not to keep such employees on staff? Unfortunately, it’s not possible. For instance, you can’t expect to have inquiries on your website without a marketer’s efforts, or submit a tax report on-time without an accountant. If it were possible, project-based businesses would be more stable and predictable because we wouldn’t have to bear indirect costs all the time.
Of course, not only employee expenses can be classified as direct or indirect costs. This classification can apply to any type of expense. Furthermore, it’s very difficult to separate indirect costs in reality. For example, when a senior backend developer sets up Zabbix for your entire company, it is likely to be considered as an indirect cost.
Therefore, the question arises: how do we differentiate work that is sold to customers from work that we pay in order to maintain and develop the company? Without addressing this issue, we are not confident enough to discuss financial objectives.
The metric that will help you to distinguish indirect costs from direct ones is the employee productivity rate.
How to measure a programmer’s productivity rate? Unfortunately, in the context of their activity there is no metric for that. For instance, in the manufacturing sector you can easily count how many items a worker produces regarding their quotas. But, it is impossible to do so with a programmer due to the high level of abstraction of their work.
For this reason, we simplify the entire scenario by making an important assumption. We do not assume that developers spend their whole day contemplating the perfect line of code while playing video games or surfing, and then quickly program a feature that was estimated to take 5 hours in just 5 minutes. Instead, we assume that developers spend all their paid time in front of their laptops, working diligently on the code to ensure that the tool meets the client’s requirements. In other words, we assume that an employee with a fixed salary “should” spend every hour of a working day of the month focused on their assigned tasks.
Yes, we can already hear the sound of CTOs laughing out loud at this part of the article. But that’s okay. This article is aimed at financial and operational executives – so maybe don’t show it to CTOs 🙂.
Here we come to an important point: actual worklogs are essential if we want to differentiate between the work of our employees that we resell to customers and work that we pay for as indirect costs. Therefore, it is necessary for your employees to log their working hours for every task they work on, whether it involves coding or attending a meeting.
It is important to consider how much time an employee actually works and how much value their work brings to the company. This allows us to not only understand the project’s economy but also to fairly motivate team members. For example, if we see that their activity has contributed to an increase in profits, we can consider raising their salary.
Let’s consider a hypothetical example that clearly illustrates the importance of such calculation:
Project A estimate is 40 hours of work and you sell it to a client for $4000. During the project, a programmer worked for 20 hours at a rate of $50 per hour, which amounts to $1000. The remaining 20 hours were billed by a UX designer, project manager, and QA tester, also at a rate of $50 per hour, resulting in another $1000. Therefore, the total costs for the project were $2000 ($1000 for the programmer and $1000 for the other team members). The project’s profitability is 50%, or $2000 ($4000 revenue – $2000 costs).
Project B estimate is 10 hours of work and you sell it to a client for $1000. During the project, a programmer and a project manager worked for a total of 10 hours at a rate of $40 per hour, resulting in $400 of expenses. The project’s profitability is therefore 60%, or $600 ($1000 revenue – $400 expenses).
Obviously, the efficiency of Project B is higher, although it may not seem so at first glance. But to keep a hand on the pulse of your project business you need to execute such calculations regularly for each employee, each task, and each project. In other words, you have to systematically track the project and task profitability in different scales and filterings. With the ability to input this data to a dashboard in a convenient way. It doesn’t sound like a piece of cake? But we have developed an automated solution for that. Let’s look at it in detail.
The main goal of automation is to have a clear understanding of the relationship between spendings and tasks. In other words, every cent we spend must be associated with ongoing tasks. To achieve this, we need to:
1. Collect all work logs for each task.
2. Convert collected work logs into money.
3. Deduct that “work log money” from the salary of each employee.
Let’s delve into the details further.
Example of P&L automation at WBT-Global. In this example we use Jira Software as a task-tracker.
Tools that we use
A Task-Tracker – a software tool where individuals or teams log their time for tasks and projects. In this example we take Jira Software, but there are many options available, including Trello, Asana, Monday, Microsoft Planner, and others.
Financial software is a tool for managing accounting and payrolls. It should have a reliable API for integration with other systems. Some popular examples of financial software include QuickBooks, Odoo, SAP Financials, Sage, and more.
Integration Tools – in this article we use no-code solutions like Zapier or Make to connect a Task-Tracker with a Financial Software.
As a software company, at WBT-Global we use Jira as our task management tool, which we consider to be an ideal solution for software teams. Our Jira workflow includes the following steps:
1. Each client is treated as a separate Project.
2. Within each Project, there are Epics – which are large bodies of work that can be broken down into smaller pieces called Issues (Tasks).
3. Issues (Tasks) represent the results of the work done by each employee who contributed to a particular Epic or Project. This is where employees log their time.
We will now “convert” the time spent by each employee on each task into money. To do this, we need to calculate the actual hourly rate of each employee based on their fixed salary. The actual hourly rate is different for every employee and varies every month. How does it happen that the rate changes each time?
Employees with a fixed salary receive the same amount of money every month, regardless of how many days they were on sick leave, or how much time they spend drinking tea and watching YouTube during working hours. For example, let’s imagine that we have an employee named Peter whose net fixed salary is $5000 per month.
If we assume that Peter worked the entire working month (22 days x 8 hours = 176 hours) and there were no public holidays or additional day-offs, then his hourly rate is $28.4 ($5000 / 176 working hours within a month).
Let’s consider a more realistic example. Suppose Peter took 4 paid day-offs and had 3 days of sick leave. In other words, he worked only 15 days (22 working days – 3 day-offs – 4 sick leave) resulting in 120 hours (15 days x 8 hours). In that case, his actual hourly rate for the same month would be $41.7 ($5000 / 120 working hours within a month). Quite a difference, isn’t it?
Now we can multiply Peter’s actual hourly rate to each of his worklogs (hours logged to each task) and we’ll see the real cost of each task executed by Peter.
Since we don’t make daily microtransactions to Peter, we need to determine the real cost of each task within Peter’s salary. To achieve this, at the end of each month, our program analyses all Peter’s tasks by gathering his worklogs, multiplies them by the calculated actual hourly rate of Peter, and breaks his salary into components. Each component represents the real cost of a task. The remaining portion of Peter’s salary, which is not related to any task or taxes, would be the indirect costs associated with Peter’s salary.
|1. Calculating the expected number of hours Peter was supposed to log, and excluding days off and sick leaves.||As we calculated previously, Peter took 4 days off and had 3 days of sick leave. As a result, he worked only 15 days, 8 hours per day, totaling 120 working hours in the selected month.|
|2. To calculate Peter’s actual hourly rate (net) for the current month, we divide his fixed net salary by the expected number of hours in the same month.||As previously stated, Peter’s fixed net salary for the month is $5000. Therefore, dividing his salary by the precise number of hours he worked in the current month (which is 120), his actual hourly rate is $41.7.|
|3. We will now assess how Peter performed against his quotas for the current month by comparing the actual number of hours in his worklogs with the expected number of hours he was supposed to work.||As we calculated, Peter was expected to work 120 hours in the current month. However, upon analysing his work log, we found that he only logged 110 hours. Therefore, the 110 hours he worked represent how Peter performed against his quota for the current month.|
|4. Calculating the indirect costs associated with Peter’s salary involves identifying the portion of his salary that is not directly attributed to any specific task or project. Minimising such costs can significantly contribute to the overall stability of your business.||To determine the indirect costs associated with Peter’s salary for the current month, we multiply the actual number of hours he worked (which is 110) by his actual hourly rate of $41.7. This calculation results in $4587.
Subtracting this amount from Peter’s fixed salary of $5000, we obtain $413, which represents the indirect costs associated with his salary for the current month.
Important note! These calculations don’t prove that Peter was loafing during all the unlogged time. However, they do show us the actual cost of his work. When managing a project-based business with numerous employees, managing such information in real-time is essential for building financial projections.
To automate this workflow, we have developed an “Effectiveness Plugin” – a Python program which performs the necessary calculations in the database and synchronises the results with your financial tools by API in real-time. In other words, this program provides up-to-date data on the indirect costs associated with your staff.
– When your employee receives payment, the Effectiveness Plugin collects all their work logs for the same month from your task-tracker.
– The plugin then compares logs from your task-tracker with data from your financial software to determine tasks related to client orders. That is to say, we are checking whether these tasks are income-generating and will be paid for by a client. If the tasks are related to a client project, the program maps them to the corresponding client project.
Now we know the productivity rate of each employee, as well as the remaining portion of their salary, which is not related to any task. And all of this is available in real-time since the data is updated daily.
In our experience, if an employee fails to track their time properly, it may be a sign that they are burning out. If there is no time to track, it could indicate that there is an issue with the workflow. This presents an opportunity to communicate with your team members and work together to identify and address the problem.
Now that we have broken down all the expenses and calculated the profit for each task and client project, we can determine the profitability of all our projects at various scales (for example, by clients). In other words, we can now create more realistic P&L reports for our projects. At this point, it’s just a matter of technique.
Even if each of your projects is profitable, the actual profitability of your company will be lower when you recalculate it, taking into account all indirect costs. In other words, when you consider all the hours that are not allocated to any of the client tasks: operational work, accounting, marketing, HR, and any other employees who didn’t log their working hours to client-related orders.
Reduce indirect costs – this will make your business more predictable.
What you can gain from implementing the practices described in this article:
– A more accurate P&L report (Profit and Loss) – showing how much the company has earned and spent.
– Taking into account all profits and losses for a specific period – for example, a month, quarter, or year.
– The ability to separate direct costs from indirect costs.
– Calculating the productivity rate of each employee.
If you’re tired of guessing the real profitability of your projects, you might find our solution interesting. Start managing your indirect costs, tracking the efficiency of each employee, task, and project systematically and in real-time. No more manual work in spreadsheets. Create your dashboards and receive data automatically. Contact us to take a closer look at our solution and see how it can transform your business today.