When it comes to your organization’s accounting and financial processes, it may seem like there are countless things to consider. However, when you take a step back and look at the big picture, there are really only a few key factors to determine whether or not your organization succeeds financially.
Utilization, cash flow management, and bill rates are all accounting practices that have the potential to have an impact on your company’s financial future. To find out more about how each of these factors can affect the performance of your organization, keep reading for an explanation of each term and account growth strategy tips for your business.
The first points to consider are bill rates and billable hours. Both have an impact on cash flow, profit, and gross margins. Optimizing these can be a challenge, but one tip is to target 80% utilization to drive billable hours.
Another important point to understand is that bill rates and consultant productivity are the primary consulting profit levers. Any given percent increase in either utilization or bill rate has a similar bottom-line impact. The result is that service margin cannot be produced if executives cannot charge at least double the fully loaded cost of consultants, or if average billable utilization falls below 50%.
Billable rate = $100
At 55% utilization, lose money
At 60% utilization, lose money
Not until 70% utilization do you start making money
Billable rate = $175
Profitable at 60% utilization
Not until 40% utilization do you lose money
When rates are low, like in IT Services, you must drive high utilization to drive profitability.
When rates are high, like management consulting firms at $400–500 an hour rates, you can operate more profitably at lower utilization.
Should I Increase Volume, Rates, or Utilization?
Consider this example:
A professional services firm that is not profitable has a $6M a year business with negative cash flow. What do they do? Let’s take a look at 3 different pathways:
If they increase volume, it will improve revenue, but still have negative cash flow. Why? For every additional unit of volume, the business has to hire another consultant making it harder to achieve profitability.
If they increase rates by 5%, this creates positive cash flow as well as profits. There is an increase in operational profitability. Increasing rates has a more impactful outcome than an increase in volume as it optimizes cash flow and has a greater impact in operational profitability.
If they increase utilization and add a 1% utilization, this reduces direct costs as a percent of revenue. This will indeed grow their cash flow, but it doesn't impact profit. However, it will impact direct costs.
4 Strategies to Increase Gross Margin
Gross margin is the difference between the cost to deliver and the selling price of a company's products. It is also known as gross profit because it is the profit before accounting for other expenses, such as operating costs, depreciation, or amortization. Gross margin is an essential metric because it indicates whether a company has a competitive advantage in its market.
If your business has high fixed costs and low variable costs, you will want to focus on increasing your gross margin so you can recover those fixed costs more quickly. Companies can improve their gross margins by reducing delivery and production costs and increasing selling prices.
Here are some more strategies to help you increase gross margin:
Be very clear about what margin you’re making and what rates you’re charging on each project and slightly increase them.
Focus on rate increases to drive profit instead of increasing volume to drive revenue. This way, you don’t have to add consultants or capacity.
Go through old MSAs and examine the rates. You may notice you have rates that are 3, 4, and 5 years old. Create a systematic way to update your rate schedule.
Manage your rate schedule and pricing, especially in a period of rapid inflation with costs going up. Look at total direct costs and have corresponding increases in rates to offset them. Conduct periodic reviews and look at these at least twice a year.
In summary, this section has demonstrated the powerful effect of the 2 primary consulting profit levers and their effect on the bottom line: consultant productivity (also known as billable utilization) and average bill rates. Focusing on rate increases will ensure you are not exhausting resources. Make sure to take a look at old rates and adjust as necessary. Slight increases are always better than vast ones. Finally, look at your rate schedule during economic shifts, and conduct reviews periodically.
One final key piece of information to leave with today is this:
At the beginning of your consulting maturity journey, a good place to start is by measuring your consultant billable utilization and your average realized bill rates. Once you establish a baseline, strive to continually improve both measurements.
We Can Help
We hope this information has helped you understand that profit comes from the right balance of revenue and costs. By now you should know that bill rates and utilization have a powerful effect on profitability and how to navigate from low margins to higher margins. Finally, bill rates and consultant productivity are the primary consulting profit levers, and organizations must make sure both are optimized.
Let ALTA Consulting help optimize your profitability levers. Book a call with us here.