Improve Profitability by Limiting the Escape of Billable Hours

As simple and obvious as this sounds, one of the biggest sources of lost profit for a professional services firm is the escape of billable hours, that is hours that were worked by an employee but did not eventually translate into a paid, billable hour.  Below, we will describe this in more detail and provide some recommendations to improve profitability at your services firm by reducing the escape of billable hours.

Despite the variety of ways in which professional services firms’ market, price, and sell their services (e.g. fixed price billing, success-based fees, time-and-materials, etc.), fundamentally the firm’s means of production are hours.  Professional service firms are selling their skills and expertise in the form of hours devoted to the client, the engagement, or the project.  More hours billed to a client equals higher revenue.  If the revenue is produced with a positive margin then more billable hours equates directly to higher net profit.  If production costs are fixed, i.e. salaried employees without a variable incentive structure, then nearly 100% of the additional revenue falls to the bottom line in the form of profit.

However, not all hours worked always translate to hours billed.  Understanding the flow of hours through an organization is paramount to a deep understanding of the financials of a professional services firm.  To do this, map out the flow of hours through the organization and measure the relationship between hours billed and paid by clients relative to the hours worked by billable professionals.  There are a variety of names for this relationship, including realization, utilization, chargeability, etc.  We often refer to this as ‘utilization.’

So if not all hours worked translate to hours billed, where are the opportunities for diversion of hours into non-billable activities?  Where is the loss?  The loss comes from two primary categories:

1)     the reduction of utilization, intentionally or unintentionally between the various steps between an hour worked and an hour billed, and

2)     the decrease of monetization of an hour utilized (via management ‘factoring’ hours, client contention, or client non-payment).

Let us look at a typical waterfall of hours for a prototypical employee in a professional services firm:

It helps to think through the waterfall of hours for a prototypical employee to develop a sense of ‘hours escape’.  First – consider all the non-billable administrative time that a typical employee engages in per week.  This includes internal meetings, training, development, time tracking, lunch breaks, etc..  In our experience, it is not atypical to see around six (6) hours per week of this ‘admin’ time per employee.

Second – consider the average weekly paid-time-off of a typical employee.  If a company has five (5) company holidays per year and an employee has five (5) sick days and ten (10) vacation days per year, in total this equates to three (3) hours per week on average that the employee is paid, but not generating billable hours (20 days x 8 hours / day = 160 hours, 160 hours over an average of 2,000 total hours per year = 8% loss due to vacation and PTO).

Next, consider all non-billable client time.  That is time spent working on client work that is not considered billable.  This can include documentation, SOW review, scoping, invoicing, project management, etc.  It’s not atypical for this to consume an average of two (2) hours per week for an employee.  At this point of the employee’s originally forty (40) total available hours, we only see twenty-nine (29) hours available to be billed to the client.

The next typical diversion point for billable hours is what we’ve affectionately come to call ‘factoring.’  This includes the time that a project manager, sales team (if involved at this point), or senior leadership removes due to quality of the work performed, non-conformity with an SOW, etc. We typically see this manifest in the following logic “well I know Employee ABC worked on this function or this feature, but the client didn’t ask for this, I can’t bill them for this.”  Or perhaps we hear “I can’t bill the client for that time, it never should have taken Employee ABC that many hours to complete that task.  If Employee XYZ had done that, it would’ve taken half the time.” What we typically see is that some employees on some engagements, managed by some PMs never have a single hour factored, while other employees on other projects can easily have twenty (20) or so hours per month factored out of their billable time.  The distribution of ‘factored’ hours is wide across most employee bases.  In our example above, we assumed around one hour per week per employee of this factored time, reducing average net billable time down to twenty-eight (28) hours per week.

Lastly, the final risk of escaped billable hours comes at the point of eventual payment from the client.  We see a variety of factors divert invoiced hours to eventual paid hours.  This includes a client contesting hours spent on tasks or contesting the quality of the work.  This includes the client being unable to pay an invoice due to financial trouble.

In our example above, the prototypical employee may have begun a typical week with forty (40) available hours, but only twenty-seven (27) of those hours resulted in paid, revenue generating work.  That is a conversion rate of 68% on those hours.  Although this may not seem like a big deal, the implications can be quite staggering.  Consider for a moment the kind of rough, back-of-the-envelope math most operators do when considering if someone is profitable.  It is not rare for us to hear an operator walk through the following logic: “The person’s salary is $120k per year.  They work around 2,000 hours per year so that person costs me $60 per hour.  I’m billing them out at $95 / hour so I’m making $35 / hour.  That’s a pretty good margin.” 

But let’s look at actual margins when we account for burden and utilization:

If billed at $95 per hour, the company is losing money on that individual.

How Ballast helps professional services reduce escape of billable hours:

1)     ‘Map out’ the flow of hours worked to hours invoiced and collected. Determine how many people, systems and processes does the billable hour touch before it is converted to invoiced revenue.

2)     Implement hours tracking and project-management systems that suit your firm’s needs.

3)     Create controls and a set of objective standards for billable employees to determine what tasks are billable and non-billable.

4)     Set clear permissions and protocols for who can factor hours and for what reasons.

5)     Create thresholds for allowable factoring at lower levels, and approval protocols for hours-factoring above those thresholds.

6)     Create a paper-trail of hours factored at various stages to avoid excessive or duplicate reductions for the same reasons.

If you think your business could benefit from a review of its hours entry and billing process, to reduce escapes and improve earnings, please do not hesitate to contact us.