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Why Do Projects Turn Out To Be Unprofitable?
The answer to this question is never easy.
Some projects face extensive scope creep, and in others, contract imperfections are to blame. However, in the majority of cases, projects were doomed before they even began.
Dlaczego?
Because their profit margins simply failed to include all the costs a project needs to cover - or, in short, the project budget was based on the assumptions from an incorrect margin degree.
What Are Margin Degrees?
Margin degrees show companies the impact of different costs on the project profits.
There are overall three margin degrees:
- 1st-degree margin, only involving costs and profits directly related to a given project.
- 2nd-degree margin includes incomes and expenses from the projects and the share of costs of unutilized and non-billable time in the company.
- 3rd-degree margin that considers all of the above costs, as well as the company-wide expenses required to keep the business running.
But why should you bother with margins other than the 1st-degree margin - and what can your business lose by not doing so?
1st-Degree Margin: The Misleading Smokescreen
A 1st-degree margin is used by the majority of the companies - and wrongfully so.
With only the information on project costs at hand, such as costs of work, software, and supplies, it is easy to conclude that the expenses are, in fact, very bearable, even with low rates. Such an assumption often leads to lowering service prices or assigning expensive, experienced specialists to simple tasks based on the assumption that the budget can cover their rates.
2nd-Degree Margin
The second-degree margin is significantly closer to the truth, as it also takes into account:
- The costs of unassigned, idle - or benched - employees,
- The costs of non-billable and internal projects that do not generate any profits.
The value of those hours is then divided proportionally between the projects based on their duration or costs to calculate the second-degree margin.
3rd Degree Margin
While the second-degree margin is much closer to the truth, only the third-degree margin can accurately represent the actual financial state of the project. That is because, apart from the costs of work and non-billable hours, it also includes:
- Costs of utilities, leasing, and office/rent.
- Costs of necessary equipment, devices, software, and office supplies,
- Costs of supporting activities, i.e., recruitment, marketing, or sales.
These expenses usually account for thousands of dollars - enough to jeopardize any project. That is why knowing the third-degree margin is essential for any manager wishing to avoid unpleasant surprises at the end of the quarter.
Difference? Success Or Fall Of Your Company
From the first-degree margin perspective, the financial problems are nearly non-existent. A company wishing to achieve a 30% final profit margin just needs to add 30% to the costs of the work, giving them a $13.000 income for a project incurring $10.000 worth of workload. Simple, straightforward and extremely misleading.
From the second-degree margin perspective, the costs are slightly higher, as the project must also pay for its share of non-billable hours divided between all the projects. In this case, that expense will cost the project another $1000, shrinking the income further.
Still, the final blow comes from the third-degree margin. With company-wide expenses on board, every project usually needs to cover hundreds and thousands of dollars of additional spending. In a case like this, with only $2000 left, those costs make the difference between success and failure.
Master The Profit Margins In A Single Tool
Naturally, you do not have to experience such a scenario yourself. You do not even have to spend hours calculating all of the margin. You simply need to have the right tool.
Try the BigTime solutions to gather all your project and financial data in a single source of truth and:
- Monitor the real costs of work whenever your specialists track time.
- Check the costs of billable and non-billable hours.
- Get access to automatically updated and calculated profit margins that include all the costs.
