The utilization rate formula - why is it so important?

Let’s get real. Do you take some time each week to measure and analyze your utilization rate? What is utilization rate in the first place? And how it can affect your professional services?

If you don’t care about this aspect of running your business, you risk ending up with inflated overhead costs, problems with financial performance and sinking profitability.

Calculating utilization per employee, team, or project can reveal a lot: from unhealthy processes and overloaded team members to serious staff shortages that threaten your delivery. 

When translated into actions, these insights increase your profit margin and make your teams happier.

But don’t worry, it’s never too late to start. This article goes over everything software companies should know about measuring, implementing, and analyzing the utilization rate (+ a handy utilization formula and a guide on how to calculate utilization). 

Key takeaways:

After reading our text on utilization rate in professional services, you will know:

• what a utilization rate and capacity utilization rate are,
• how does a utilization rate formula looks like,
• how to find the utilization rate for your business, projects or employees.  

What is utilization rate for a software company? Definition

The utilization rate is defined as the amount of time an employee spends on billable work (client work) vs. the total amount of time that this employee is available to work.

What is utilization rate all about? Employee utilization rate tells how much of your available time is dedicated to commercial projects.

How does the utilization rate affect professional services in IT?

What does that mean for a software development company like yours?

• Time & Materials - If your projects are mostly T&M, your goal should be achieving the highest possible utilization (unless you have a budget cap on the project). It directly translates into higher company revenues and optimal billing rates, as well as better profit margin.
• Fixed Price - If most of your projects are Fixed Price, you should focus on getting the number of hours that reflect your initial estimates. This is how you avoid wasting your budget and generating resource costs overhead.
• A mix of the two - If you run both types of projects, you need to have a masterful grasp on utilization. Regardless of your project types, the utilization rate shows you how much time your people actually spend on work, and how much time goes into nothing.

What are the types of capacity utilization rate?

Utilization is generally divided into two types:

1. Scheduled utilization - this is the utilization rate that you plan for employees to realize during the project against their total capacity.
2. Tracked utilization - this is the actual utilization rate based on the number of hours logged by employees.

Thanks to this approach, you can compare your plans to reality and easily draw conclusions for the future.

Resource planning and allocation solutions can help you a lot in making sense of it all -and run utilization formula operations smoothly.

For example, in Primetric you can divide resource utilization into Scheduled and Tracked, covering both billable and non-billable working hours for your professional services.  As a result, you can see the total average labor hours and you can see whether your ideal utilization rate is within reach.

This chart shows the number of scheduled working hours (billables and non-billables) against the number of hours logged by employees. The light green space marks the level of 100% utilization, so you can easily tell when things went overboard. As a result, you can see whether the ideal utilization rate is being achieved.

Why do software companies use utilization rates? 

Avoid bench time

If you don’t know how much you can deliver, you’re likely to end up underutilizing your employees. Lack of control in this area lands your team members on the bench. And having your people spend too much time on the bench isn’t good for your business or their satisfaction from work.

Clarify employee workload

When you know your team members’ utilization rate, you can make smarter and well-informed decisions for your company. For example, you and people in different departments as well know who could deal with a new project or work package in an existing project.

Identify staff shortage

If your development team is working at a 95%+ utilization rate and your QA team is operating at a 75% utilization rate, it means that your developers have a much higher workload than your QA specialists. Now that you know that, you can do something about it, like hire more develop

Check the health of your process

A reasonably high resource utilization rate is a sign that your process is healthy and productive. But a lot depends on your approach and service offer. It means something different for a project-based software agency and for a company that specializes in IT body leasing.

Anticipate utilization problems

A software platform like Primetric allows checking historical data but also forecasting your utilization. By running utilization formula operations and checking this future utilization rate, you can quickly react - for example, hire additional resources or pass the info to the sales dept about resource availability so they can find projects for them.

In the end, running utilization formula operations is all about increasing the organization's profitability and using your resources better.

• How do you tell that your employees are great performers? Take a look here: How to track employee performance: expert guide

What is a good employee utilization rate?

Research from HubSpot among digital agencies showed that most aim to target an 85 to 90% utilization rate but end up having a much lower average utilization rate at 60%.

This sure is interesting but totally meaningless.

A perfect utilization rate for a software development agency - or any other company type for that matter - doesn't exist. A perfect formula for calculating it doesn't exist either. 

That’s because every company is different. It has different project types, settlement methods, and specializations. 

How to calculate utilization rate for an employee?

Imagine Mark, a frontend developer who works in a Polish software development company. 

In 2021, Mark worked for a total of 221 days. He spent 26 days on vacation and took 5 days off because he got sick. 

So, how do you calculate Mark’s utilization rate? Here's a handy utilization formula

The first step is to establish his capacity. Otherwise, we don’t have any number against which we can compare the number of Mark’s billable hours.

In 2021, Polish workers worked for 252 days. Multiply this by 8 hours and you get 2016 hours. This gives us 168 hours per month, on average.

But employees need to have a lunch break, right? So it makes sense to give Mark 1 hour off each day for lunch. When we multiply 252 days by 7 hours, we get 1764 hours (147 hours per month, on average).

Every employee in Poland gets 26 days of vacation leave. So it makes sense to include this in our calculation. We now have 226 working days, so 1808 hours (150,7 hours per month, on average).

But Mark also took 5 days off that year because he fell sick. 

So, Mark’s total capacity is 221 days which gives us 1547 hours in a year. 

In 2021, Mark logged 1428 billable hours. 

If we take all of that into account, we see that Mark’s utilization was 92% (1428 hours / 1547 hours = 0,92). Now you know how to calculate utilization!

What to do if your utilization rate is low?

You ran the utilization formula and discovered that it's low. What can you do now? Low utilization means that your employees dedicate a lot of time to activities that aren’t client work. They don’t generate profit for your company.

That means you’re losing money.

But a high number of non-billable hours doesn’t automatically mean that your company is in trouble. 

If you run the utilization rate formula when building a new product or internal tool, don't be surprised to see low utilization. 

But here’s the question: How can you tell that the number of non-billed hours is proportional to the tasks at hand?

The best method is to simply check where all the non-billable work goes into. In Primetric, you can narrow down the utilization analysis to a specific project or team. By going down into the details, you can easily check whether your team’s precious time isn’t leaking somewhere. 

However, low utilization can also mean that you’re not doing a good job in resource planning and allocation. 

Your employees are just sitting around the office doing nothing. Obviously, that’s not great for your business.

This is where a resource planning and allocation tool can help you to fix that. Future Mind implemented Primetric to gain more control over resource allocation, generating forecasts and then checking how they compare to reality. This helped Future Mind to optimize their resource use, reduce bench time by 4% and increase the number of billable hours by 3.500.

What if your utilization rate is 100%?

If you note a consistently high tracked utilization (the actual work logged by employees), it means that the team members spend all their time working on client projects. 

This might mean that they’re overworked. Or that you’re not investing enough in their professional development or team-building.

In the long run, a 100% tracked utilization rate could pose a serious danger to your business.

How to implement a utilization rate formula in your company?

a. Start by tracking the working time of your employees

Wait, scratch that.

This is not a good approach to calculating your utilization.

Why? Because if you fail to structure your input data before starting to log time, you’ll end up with a lot of logged hours for thousands of different tasks. Total chaos.

This is why your first step should be: 

b. Identify what you’re going to measure (and how precisely)

Billable vs. non-billable

Are you only going to track time on billable projects? Or maybe your employees will also track time on non-billable activities? If so, only for large projects or also activities like workshops and team meetings?

Level of precision

Let’s say you decide to track billable hours. But at which level of granularity? Will your employees track time per project, project phase, or individual task? 

Your choice here will depend on two things:

• How you’re planning to settle with your client (some might want reports down to the level of individual tasks)
• How far you want to go when analyzing time spent on billable tasks.
  

Whatever you decide, make sure that logging time is easy and comfortable for your employees. The time tracking software you use must be user-friendly and intuitive. 

Ok, but how to start tracking time at your software company?

If you’re already tracking time at your company, congratulations! You’ve already completed the first step. 

If your employees aren’t logging time yet or you’re struggling to convince them to, read this article to learn how to structure the process of logging time so that it brings you a wealth of data and doesn’t cause any discomfort to your employees.

c. Consider an employee’s capacity when planning

Capacity is a critical measure for understanding the utilization rate of individual employees. In Primetric, you can analyze both scheduled and tracked utilization. 

Scheduled utilization = Number of planned hours in a given period / Total employee capacity

Tracked utilization = Number of logged hours in a given period / Total employee capacity

Total employee capacity = Employee’s total available working hours - (public holidays + holiday or sick leaves)

When measuring an employee’s utilization, consider the real capacity of that person.

‍Potential threat alert! This capacity might change in time, so keeping your data in order might become a problem.

d. Check how many hours employees spend on billable and non-billable work

1. Find 30 minutes each week for analyzing your utilization rates. Pick a specific day and stick to it.
2. Generate a report per project and per employee.
3. Compare utilization to capacity. Analyze billable against non-billable tracked hours following the formula I mentioned above.
4. After some time, you’ll be able to analyze your utilization rates based on historical data. You can establish an indicator that is satisfactory for your company. It will serve as your reference point.

How to determine such an indicator? Here's a simple method:

• Your first goal is to convince your employees to log their working hours correctly.
• Then you’re ready to come up with your indicator. 
• Measure the average cost of your employee. Make sure to include the company and project overhead costs. 
• Then compare it with the average revenue rate on the project.
• This will help you to determine what the minimum billable utilization should be to keep the right margin.
  

5. Optimize the number of billable hours and your indicator depending on the use case at hand:

• Reduce or increase the number of non-billable hours,
• Transfer workloads from overloaded workers and to those who have less work on their plate.

e. How to eliminate data about employees who can’t bill a lot of their time (like team leaders)?

Not all employees will have high utilization rates, even if they work hard and bring in a lot of value to your company. We’re talking about managers and team leads here.

So, how can you still get a realistic utilization rate for the project, team, or company?

There are few approaches to that:

1st approach - treat non-operational people as an overheads:

Treat such people as an overheads, and then calculate the participation (shares) of each project in the organization's overheads. How? By dividing the total number of billable hours and scheduled billable hours for a specific project.

What it gives you? You can simply check what should be minimum margin on every project to cover all your overheads inclusing non-operational employees.

2nd approach - track time of non-operational people as non-billable activity per each project

You can track their time as a non-billable activity, and then see how many hours they spent across billable projects, and other activites.

f. Be aware of threats related to measuring your utilization rate

Changing employee capacity 

Why does employee capacity change? Because a few factors will keep on influencing the formula:

• Number of working days in a given period (consider public holidays here too)
• Vacation leaves
• Sick leaves
• Duration and type of employment (full-time, part-time, freelance)
  

Changing utilization rates

This is completely normal. A software company is a living organism where requirements constantly change. A client might want new functionality, a new account might suddenly knock on your door, or one of your employees might quit. 

Calculating all of this manually is hard. This is why I added a feature to Primetric that allows checking utilization rates depending on the level of certainty we have about projects and assigned resources. 

Here’s an example scenario:

You’re measuring resource utilization, everything works fine, and then suddenly the sales department comes and says that there’s an 80% chance that your business will acquire a new project. After the initial time and financial estimates, you need to find people who could carry it out. 

You found them, but now what? You can plan them in your software platform or spreadsheet, but you’ll see that the planned disposal has increased. What if your client goes with another firm, and suddenly the people we planned will be left without the planned work? Your utilization rate will drop sharply.

To avoid such surprises, Primetric allows booking and drafting people for projects, and creating uncertain projects. All of this is reflected in the chart. Thanks to this, you can see what your scheduled resource utilization looks like for projects that are happening for sure and those that are uncertain. 

In Primetric, you can use reservations for certain projects and drafts for uncertain projects that have not yet been confirmed by the sales dept:

The three icons next Assignments have the following meanings: black - draft project, yellow - reserved project, green - active project.

g. How to measure real utilization and bill the client differently?

Sometimes you have a project underway with a few full-time developers working there. But in the meantime, they still attend internal meetings and sometimes even jump quickly on another project for a few hours a week.

On the one hand, you want to use time tracking to generate an invoice for the client. On the other hand, you want to see the real utilization of your employees and the actual time spent on this project.

Here’s a solution. In Primetric, you can log working time in many projects at the same time. But when you invoice the client, you can enter the appropriate number of hours and the billing rate you agreed upon. 

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h. When to implement the utilization rate formula?

When you stop having direct control over what’s happening at the company. Small teams are easy to manage. 5-15 people. But a larger structure with PMs with their own responsibilities, nobody knows who is doing what, and this translates into a lack of knowledge about effectiveness.

If you start feeling that you lack knowledge about what’s happening in your projects, and the sales, PMO, and dev departments switch their requirements and fight for resources, it means that it’s time to measure utilization.

It’s all about the health of your business. Even at the initial stage when you have the impression of being fully in control of the situation, it’s worth following your utilization rate and optimizing it over time to increase profitability or simply anticipate bench time/workload problems.

i. Who should be in charge of measuring the utilization rate?

It all depends on the company size and the responsibilities around resource allocation in a given company:

• Self-organization and distribution
• Top-down management
  

Most of the time, measuring the utilization is the job of a COO in smaller companies and a Resource Manager in larger ones. 

In some companies, people responsible for project management have more responsibilities and assign people to projects or take care of resource allocation. The COO then checks if everything works well and the utilization rate is high (especially important in T&M projects).

Over to you

Calculating and analyzing employee utilization rate can get tricky, especially if you’re juggling data from different spreadsheets and don’t have any automation tool in place.

Also, you probably don’t have much time on your hands for this. But you still need these insights to manage your profit margin. Compiling data from spreadsheets and reports manually isn’t going to cut it.

A platform like Primetric does all the heavy lifting for you. It combines time tracking features with resource planning and allocation cut out for software development agencies’ needs.‍

If you feel overwhelmed by your spreadsheets, looking for a single source of truth, or trying to make sense of your allocations, sign up for a demo to see how Primetric could help you eliminate bench time and increase your billables.