Method 1 was to let the software figure out overhead allocation each month. Completely automatic. Check the box and forget it. The downside was that the results often loaded up a project with an excessive overhead allocation. This might be due to a large annual expense falling due that month, say professional liability insurance. Method 1 was fully automatic – and useless.
Method 2 was to input an overhead allocation factor. This factor was used to allocate overhead per hour of time charged to the project. This method gave consistent results and they were accurate as long as your overhead factor was realistic. We knew how to calculate a realistic overhead factor, and you can see how here.
I think there are several reasons for knowing your project profitability.
timely profitability calculations let you take corrective action when it is needed
identifies the ‘good’ projects and the ‘bad’ projects
lets you determine if a project is good/bad because of size, type, personnel
informs business development decisions without resorting to fantasies
How To Determine Project Profitability
Determining Project Profitability is actually pretty simple. You allocate your overhead expenses based on the hours charged to the project. You simply multiply the Overhead Factor times the individual’s hourly pay rate. Then add this amount to the project expenses for each hour charged to the project instead of just the hourly pay rate. That is the key to calculating project profitability.
Sadly only the more elaborate and costly accounting systems have this functionality. Some versions of QuickBooks can be set up to do this, but it helps if you have a degree in accounting.
I have developed the spreadsheet below as an aid in understanding the process or as a tool for making your own project profitability calculations. Download and customize PROJECT PROFITABILITY for your use.
In this detail image of the spreadsheet, I have tagged the less obvious cells with a number. These are the explanations:
- The Description column holds any information that will help you make sense of the entry later. Make it as detailed as you want.
- The Income column is primarily design fees that you have billed. It is more helpful for your purposes of project profitability if you enter income as it is earned rather than received.
- Reimbursable Expense could be combined with Direct Expense for simplicity, but I think it is helpful to make the distinction.
- Direct Expense is anything spent because of the project – non-reimbursed consultants, reproduction, mileage, and so on.
- Labor and Overhead contains formulas, explained later.
- The TOTALS row adds up all the entries below. So the bottom line is actually the top line.
- P/L is your project profitability. Income less expenses and less labor and overhead.
This last detail image shows the following information:
8. The Labor and Overhead column holds formulas in the dark blue cells. The formula adds up the calculation of hours times overhead rates for each person.
9. The dollar amount below each ‘Person’ is their overhead rate calculated per this previous post.
10. Hours are input for each Person every payroll period or as often as you wish.
If you are keeping project accounts now, this process shouldn’t add any significant time once you have it set up. On the other hand, Harvest does project profitability for you, available as a report at any time. Harvest uses your time entries and expense entries. No extra bookkeeping entries required.
Better, simpler, quicker bookkeeping.