As projects are all about the bottom line, you can imagine the importance of project profitability in project management. Being able to determine beforehand whether a project will turn a profit is how organizations can decide which projects to initiate and which ones to skip.
But what exactly is profit profitability and how does it relate to professional services teams, consultants, CFOs and accountants? We’ll define the term and explore how to analyze and measure profit profitability to help you better allocate your resources.
What Is Project Profitability?
Project profitability measures how much money a project will make for the organization that initiates it, tracking the financial gain or loss of a project. Project profitability is part of project accounting and uses profit (the revenue left over after accounting for costs) and margin percentages to express the money made.
It works by comparing the revenue collected from the work done for a client (the actual revenue) and compares that to the cost to the organization for delivering those services such as salaries and other direct costs.
Unlike rate realization analysis, which compares actual earnings with earning potential, project profitability is only concerned with comparing actual evenings against the cost of generating that revenue.
Issues that can impact project profitability include scope creep and low employee utilization. Even the type of contract that’s used can affect the profit expectation. That’s why project management software is so important.
ProjectManager is an online tool that plans, schedules and tracks costs in real time with Gantt charts. Not only that, our Gantt charts can link dependencies to avoid scope creep and filter for the critical path so you know which tasks must be completed to successfully deliver your project. You can also set a baseline to track your actual costs against your planned costs to stay on track. Get started with ProjectManager today for free.
A profit margin is used for the profitability ratio in project profitability and helps you determine which activities make money in your project. This is an essential part of project profitability as the profit margin tells you how much money you can keep out of every dollar that you earn. The larger your profit margin in a project, the more money that project will generate.
It’s easy to calculate the profit margin. It’s total project cost minus total expenses divided by total project cost multiplied by 100. Or, if you’ve already calculated the profit, you can simply divide the project profit by the total project cost and then multiply that by 100.
Project Profitability Analysis
Project profitability analysis is a project accounting technique that focuses on the health of an organization or project. It’s a way to deliver detailed data to better inform delivery management, employee management and organizational performance.
The importance of project profitability analysis is wide-ranging. The biggest advantage is that the more profitable an organization is, the more it can thrive. On a more operational level, project profitability analysis allows organizations to make better business decisions such as which projects or clients to take on based on data.
Another aspect of project profitability analysis that isn’t as obvious is that it helps align teams. When everyone knows the profit-driving projects or target clients, it puts all departments on the same track. From the project team to sales to marketing and other departments, they’ll all be working together.
How to Measure Project Profitability
You can see the importance of project profitability; if you’re not making a profit, you’re not in business. Therefore, the projects or clients you contract with have to be profitable and this is one of the metrics by which you’ll measure the project. How you calculate project profitability can vary, but all approaches should follow these best practices.
1. Evaluate More Than the Budget
It’s easy to get lost in the budget. After all, the cost is part of the triple constraint, which also includes scope and time. These are certainly critical metrics and will help you deliver the project on time. However, for project profitability, you have to have a bigger picture that focuses on the project’s profit and margin. We’ve discussed those terms above and they’re key to understanding the profit after delivering the project.
2. Start Early
It might seem like a task to focus on project profitability after the project has been delivered. While it’s good to do this after you completed the project, it’s a mistake to only perform this function at the end of the project. Project profit analysis should be estimated and tracked throughout the life cycle of the project as it’ll help make the project more profitable. Ideally, you’ll look into this quarterly to help you meet your profit expectations.
3. Always Track
Tracking is essential for managing a project successfully. That means tracking the hours your team works on tasks, tracking time spent on tasks and understanding how those hours translate into costs. It’s also critical to track the planned costs against your actual costs to stay on track and better forecast profitability in the future.
There are more practical tools to measure project profitability, and we’ve outlined some below.
Project Profitability Index
A project profitability index (PI) is also called a cost-benefit ratio or profit investment ratio. It helps you determine the potential profitability of a project. The project profitability index is equal to the present value of future cash flows and initial project investments. That’s the money earned for every dollar invested.
If a project is worth taking on, it will have a project profitability index higher than one. If it’s lower than one, the project likely isn’t viable. This is a project that will cause you to make more of an investment than it will see in profit. You’ll probably pass on this type of project.
If the project profitability index is equal to one, the project will likely break even. Even though that’s not a loss, most companies want to make a profit. It’s unlikely that there would be a scenario where this would be a viable project for an organization to pursue. This is another project that should be passed.
When the project profitability index is greater than one, that project will likely deliver the profits an organization needs to survive and grow. The project profitability index is a great tool to help make these decisions about which projects to take on and which ones should be avoided.
Project Profitability Index Formula
Let’s get specific and outline the formula for a project profitability index. The first thing you need to do is identify the cash inflows and cash outflows for the project.
The next step is determining an appropriate discount rate. A discount rate is an interest used in discounted cash flow (a valuation method to estimate the value of an investment using its expected future cash flows) analysis to determine the current value of future cash flows.
Once you have the discount rate, use it to find the present value of all cash inflows and outflows. The project profitability index equals the present value of future cash flows divided by the initial investment.
ProjectManager & Project Profitability
One key aspect of project profitability is the ability to track the project across several metrics. ProjectManager is online project management software that gives you real-time data to keep better track of your project’s profitability. Once you set the baseline on your project plan in the Gantt chart, our software calculates project variance in real time.
Track Project Profitability With Real-Time Dashboards
Setting a baseline feeds live data throughout our software. For example, our real-time dashboard automatically collects live data and does the calculations for you. The results are then displayed in colorful graphs and charts. You get a high-level view of the project across six metrics, including the cost to help you track profitability. Best of all, unlike other software products that make you configure the dashboard, ours is ready to go and no setup is required.
Another metric you want to follow outside of overall costs is the hours your team spends on tasks. Our software allows you to capture your team’s hourly rate and then use secure timesheets to track how much time they’re spending on tasks. This translates into money that’s going to impact the profitability of your project. Timesheets, beyond streamlining payroll, give you transparency into the profitability of your workforce.
These are but a few of the features that help track project profitability. There are also customizable reports that can be filtered to show only what you want to see. They can then be shared with your project stakeholders to keep them updated.
ProjectManager is award-winning project management software that helps you deliver profitable projects. You can plan, schedule and track all in the same tool, with the task, resource and risk management features to give you unprecedented control over your project. Join teams at NASA, Siemens and Nestle who are using our software to succeed. Get started with ProjectManager today for free.