Project Profitability: Formulas Explained

There are also many formulas you can use in a project profitability analysis.

This article discusses various project profitability calculations and how to optimize time tracking, cost rates, expenses, and overhead to improve your project financial management.

In simple terms, project profitability is calculated by subtracting the project’s costs or expenses from its revenue.

These expenses can include materials, labor, facilities, and other related costs. Depending on which costs are factored in, the profitability analysis will vary.

 Here’s a quick overview of the three basic key performance indicators of profitability:

Let’s explore each in more detail:

Gross profit examines your project’s profitability by taking into account direct costs only (the costs associated with creating goods or delivering services).

So, for example, if revenue on a project is $10,000, but the cumulative costs of employee salaries amount to $4,000, this means gross profit is:

Why calculate gross profit: to get an understanding into how your cost rates and employee allocation affect financial outcomes.

Net profit shows true profitability by including all project costs and project expenses, including overhead such as facility costs, costs of administrative staff, software licenses, and more.

In the same example as above, let’s say the cost of software licenses is $150 dollars, administrative salaries are $2,000, and rent costs are $3,000.

Why calculate net profit: to understand the true profitability of your business, which supports informed decisions for future projects and sustainable operations.

The profit margin shows your project profitability measures as a percentage. So, you can calculate your gross profit margin or net profit margin by dividing revenue and costs and multiplying them by 100:

Why calculate profit margin: to benchmark your project margins against other internal projects and get detailed insights into your financial performance.

There are also some additional metrics that can be used in project profitability analysis:

Here’s some additional information:

The rate of realization examines the amount of billable hours tracked vs actual hours billed, and is often used in the law industry.

This directly impacts your agency profitability — if many hours are being written off because of whatever reasons (for example, the quality of the work delivered is poor), this is a direct loss in project profitability and agency revenue.

According to community discussions, a realization rate of up to 90% is standard in most law companies:

Source: Reddit

The return on investment (ROI) is a popular project management metric which helps calculate the financial viability of various types of projects. The basic formula looks like this:

However, there are various types of formulas that use the initial rate of investment as a variable in the calculation, such as rate realization analysis or payback period analysis.

You can learn more in our article on return on investment calculations.

The project profitability index (PI), also known as the profit investment ratio, is connected with the return on investment (ROI) formula. It’s the ratio that shows how profitable your future project might be by taking into account future cash flows, with the time value of money.

So, let’s say you invest $10,000 into a project, and you want to examine future cash flows benefits for a period of four years.

If the benefits amount to $1000 per year, we need to take into account the diminishing value of money, which is calculated with the discount rate.

If the discount rate is 20%, then to get your financial gain for each year, you’ll need to divide the base benefit by 1.2 for year 1, then by 1.2 x 1.2 for year 2, and so on.

So, you’ll sum up these values, which we can call the present values of future cash flows.

So, now to get back to the profitability index formula:

A profitability index of <1, such as the one above, means that your project is not profitable. Understanding project profitability of potential projects can help businesses make strategic decisions on which ones are best to take on.

The utilization rate depicts productivity and effectiveness by analyzing time tracked on client projects.

Recommended utilization rates are usually up to 90%, though this varies depending on the seniority of your staff.

C-level staff and project managers are expected to have lower utilization due to a higher number of meetings and strategic tasks that are connected to the functioning of the agency.

In any case, anything higher than 90% might indicate that your employees are being overworked and are on the track to burnout.

On the other hand, low utilization rates might indicate issues with workflows, such as back-and-forth between team members or resource gaps that cause project delays.

Utilization directly impacts financial performance, since more billable hours worked = more revenue.

According to the profitability survey in the 2024 Digital Agency Industry Report by Promethean Research, here are the most relevant benchmarks on digital agency profitability:

When it comes to the most significant agency expenses, these include employee costs (salaries and benefits), and in the second place are app and tool costs which make up 3.7% of spent revenue in an average agency.

For professional services organizations, managing your time tracking is crucial for getting accurate insights into your project budgets.

This goes for projects billed on an hourly rate (time & materials), and any other types of agency pricing models, such as fixed-price or recurring projects.

Accurate billable hours tracking gives agencies reliable insights into how much time was spent on each task.

This improves project estimation and resource allocation, supports transparency and project scope management, and ensures good project performance.

For this, promoting an agency culture where time tracking is seen as a positive rather than a negative is important.

Another crucial aspect is to have a time tracking tool which handles all of your data. One consideration is that this tool should ideally be employee-friendly — easy to track data in and non-invasive.

The second big benefit is having a single system which handles your time, budgeting and billing:

Learn more on how agencies manage their project time tracking with Productive.

Productive is an all-in-one software for agency management, tailored specifically to support the end-to-end workflows of various types of agencies.

Its key features include project and task management, resource management, budgeting and billing, and reporting.

Here’s how you can use Productive to monitor and visualize your project profit:

First, you’ll need to manage the costs of your human resources.

With Productive, you can set up cost rates for all of your employees and contracts by defining the amount, currency, and number of hours worked per day.

You can also set up another cost rate that starts at a specific point in time to account for pay raises.

Another useful thing you can manage with Productive are custom cost rates. For example, a contract may bill a certain amount of money for one project, but a different rate for another.

Custom cost rates provide you with the flexibility to manage these cases.

You can also assign a holiday calendar to each of your employees, which will mark holidays in various views across the platform, including your resource plan.

Then, you’ll want to account for various operational costs and project expenses.

Starting with overhead, Productive calculates your overhead costs per hour. This means that you can get a better overview of your true profitability, as overhead will be spread equally across all of your projects.

Your overhead calculations include:

You can turn various categories of costs on and off to customize your final overhead calculation.

In Productive, you can also account for additional costs related to budgets and sales deals.

Expenses can be categorized by clients, you can track details such as amount, data, and description, and bill them to clients if necessary.

You can also integrate Purchase Orders with budgets and expenses for a simplified purchasing process and accurate expense tracking.

There’s an integrated Xero integration for syncing your expenses with the accounting software.

When its time to monitor your revenue and profit, you can do this with Productive’s Budgeting and Profitability charts.

The Budgeting tab depicts the amount of budget burned and the budget remaining based on hours tracked and billable rates.

By switching to the Profitability tab, you can get detailed insights into a project’s profitability based on time tracked and employee cost rates.

The basic profitability chart shows your gross profit (excluding overhead costs); to see your net profit, you can enable overhead in these calculations.

Both of these charts update in real time, so you can get real time insights into these key metrics. Furthermore, you can turn on Forecasting to predict what will happen to your financial health based on your resource scheduling.

Accurate forecasting helps project managers achieve financial goals and make informed business decisions based on reliable and timely data.

It can also help you manage risk factors such as scope creep and budget overruns.

Finally, you can use Productive’s Reporting to generate various types of insights on your projects.

Reporting pulls data from all your agency workflows, including time tracking, resource scheduling, sales deals, actual costs and operational expenses, billing, and more.

You can use one of the 50+ reporting templates, or build your own from scratch by customizing your fields, visualization, data grouping, and even creating custom formulas.

Reports can be shared by creating specific dashboards and adding them with widgets, or by scheduling to have them sent with Productive’s Pulse.

Find out more about the best project management tools for professional services.

In conclusion, delivering profitable projects is what your agency needs to ensure continuous growth. It provides you with revenue to reinvest in new opportunities and development.

To ensure that your individual projects are performing well, you can monitor various financial metrics, such as gross and net profit, return on investment (ROI), and the profitability index.

Additionally, managing your time tracking, labor costs, and overhead with the right project management software helps accurately assess project performance for financial success.

Tools like Productive offer an integration solution for ensuring financial sustainability with accurate forecasting, real-time budgeting, resource planning, and more.

You can book a demo with Productive today to learn more.