Project accounting is a necessity for firms that want to streamline their operations, boost efficiency, and increase profits. This straightforward method entails practicing accounting on a project-by-project basis. It applies to any business that works on assignments, whether you refer to them as projects, engagements, matters, jobs, or anything else.
When you start doing project accounting, there may be some essential concepts that you’re not entirely familiar with. Don’t worry though—once you learn the basics, it’s an easy process. Check out these earlier posts for more information on project accounting, and look to this glossary for a quick understanding of the terms related to it.
Project Accounting Metrics Glossary
When you practice project accounting, you’ll uncover actionable metrics that will help you benchmark and grow your business. Here are the ones you need to know.
Cost Performance Index (CPI): You can use CPI to learn the true costs associated with a project, and thus understand how efficiently you're using project funds. As a result, you'll be able to better plan for the future.
CPI = (Earned Value) / (Actual Costs)
If the resulting number is bigger than 1, there's no need to worry. However if it's less than 1, your costs are greater than the value of the project.
Earned Value: Earned value takes into account the project plan, actual work, and the value of completed work in order to help determine whether or not a project is on track. It offers a reliable projection of the future success of a project in terms of time and budget.
Effective Bill Rate: Unfortunately, most businesses cannot bill for every hour of their time, and the effective bill rate—also known as employee realization rate—takes this into account. It measures the billable value of all hours worked. It’s calculated as:
Effective Bill Rate = (Hours Worked / Hours Billed) x Bill Rate
Minimum Bill Rate: This measures what a firm should be charging for an employee’s time given its target profits. It’s calculated as follows:
Minimum Bill Rate = (Pay Rate X Overhead Multiplier X Target Profit) / Utilization
Overhead Multiplier (OHM): This is a helpful number to help a firm determine the revenue required for each hour spent on a project. The overhead multiplier is a ratio of total expenses compared to the direct project labor and project expenses. Its formula is:
OHM = Total Indirect Expenses / Total Direct Labor
Profitability: This is a very important metric to monitor throughout a project. Although the words “profit” and “revenue” are sometimes used interchangeably, they mean very different things. Profitability involves calculating costs and comparing them with what’s been billed to the client. Revenue is simply all the money coming in.
Realization: As noted above, the employee realization rate can be synonymous with effective bill rate. More generally, though, realization refers to the amount of billable hours that were actually paid by the client. Instead of measuring it as a monetary rate, it's a percentage.
Resource Capacity: Resource capacity is the amount of time your team can devote to a project. This is a crucial KPI for any project, as it relates to your most valuable asset: your employees.
Resource Capacity = (Number of Employees) x (Available Time per Employee)
Unfortunately, it's unrealistic to assume that every employee can fully devote 8 hours every day to a project. You need to assume that their available time is far less than that.
Return on Investment (ROI): ROI is one of the ultimate gauges for whether or not your endeavors are profitable and, consequently, worth your time and resources. Any project, tool, or even employee can be assessed on the basis of ROI. The generic formula for calculating it as a percentage is:
ROI = (Revenue from Investment - Cost of Investment) / (Cost of Investment) x 100
Schedule Performance Index (SPI): SPI illustrates whether or not your team is on schedule. It’s calculated as:
SPI = (Earned Value) / (Planned Value)
If the number is larger than 1, you're doing fine (just like with CPI). If it's smaller than 1, you need to catch up.
Utilization Rate: Utilization illustrates the efficiency and overall performance of an employee. It’s a comparison between the billable and non-billable value of their time entries, and is based on their target billable hours. For example, if their target utilization is 30 hours a week and the employee logs 30 hours per week as billable, then utilization is 100%.
Work in Progress: This refers to billable hours and expenses that a firm hasn’t billed yet. It is important to track this as an asset on the balance sheet and as revenue on the income statement. It helps managers understand how far along work is and acts as a booster when applying for loans.
Other Important Project Accounting Terms
In addition to metrics, these are other important concepts that you need to know in order to properly undertake project accounting.
Billability Analysis: This is a dissection of services and expenses as billed, billable, and non-billable. If you compare billable versus billed, you can see what a project has earned and what revenue you can expect.
Budget Analysis: This is a breakdown of services and expenses in relation to what’s already been used and what the project limits are. This highlights if a firm is over budget or approaching its budget limits.
Cost Overrun: This occurs when actual costs are higher than budgeted ones due to underestimation or unforeseen circumstances.
Key Performance Indicators: Key performance indicators (KPIs) are a way to measure the effectiveness of various processes and functions within an organization. Examples include realization rates, new revenue, expenses for obtaining a new client, estimation accuracy, and schedule variance.
Project Accounting Software: The right project accounting software combines all aspects of your projects and financials on one platform. It should handle project management, time and expenses, billing, accounting, reporting, and analytics.
Scope Creep: This refers to changes or growth of a project’s scope after a project has begun that can lead to cost overruns.
Staff Allocation: In many firms, payroll is the largest expense. It is important to strategically utilize employees and to avoid over- or under-allocation. Staff allocation is intended to help staff balance different tasks and to optimize workflow.
This project accounting glossary might seem overwhelming, but our goal is to provide you with all the information you need to make the right decisions for your professional services business. Once you put it all into practice, it's surprisingly simple--and beneficial!