One of the most important attributes of a successful business is clarity of strategy and the ability to assess progress and realign when things aren’t quite going right.
This is why it’s important for business owners and managers to be able to conduct a thorough project profitability analysis so that they can measure how well they’re progressing toward their project goals.
This is a crucial skill for both short-term and long-term strategies, and it’s essential for maintaining the profitability of a business.
What Is a Project Profitability Analysis?
At a fundamental level, a project profitability analysis takes all of a given business’s costs and subtracts them from the revenue the business has generated. These sums can be incorporated into fine-tuning models that utilize all accounting data. To perform a basic profitability analysis, you should use the following sum:
This basic sum will enable businesses to work out whether they’re in the plus or minus. However, we can go much further than this. Businesses that want to work out their profit margins (to see what percentage of all inflows and outflows that profit accounts for) can apply another sum:
This sum allows businesses to see their net profit as a percentage, allowing them to measure developments in profitability from year to year. This is useful, as if a given business notices a dip in this percentage, they can see that they need to either increase revenue by adjusting prices or reducing costs in order to restore former margins.
What Are the Benefits of Project Profitability Analysis?
By embracing the utility of a project profitability analysis, business owners and managers can make more informed decisions and help steer their business in the right direction. Here are some of the benefits that regular profitability analyses bring:
- Detailed insights to pass on to managers and project leaders: Understanding the factors that drive up both costs and profits means business owners and managers can pass on insights to project leaders to help make the best use of a given business’s strengths.
For example, certain services may have higher profit margins than others. In this case, managers can inform project leaders so that these services can be expanded, driving up the profitability of each individual team.
By making the information generated by profitability analyses readily available throughout the business hierarchy, business managers can help project leaders drive profitability at every level of the business.
It’s in this way that the insights gained through a profitability analysis can help drive decision-making at both the micro and macro levels, streamlining project execution.
- Increased flexibility within business strategy: By understanding precisely where profit and costs are generated by the business enables managers to see which policies work and which aren’t as successful as the business had initially hoped.
This is crucial for business planning, as by listening to the data and adapting strategies to play to the strengths of a given business, managers can mitigate damage to profitability.
A profitability analysis enables managers to see precisely where unexpected costs arise, allowing them to make the necessary decisions for getting the project back on track.
- Better understanding of costs: A thorough understanding of costs isn’t just useful for realigning specific project strategies, it’s also great for planning future business expansions and tech stack costs that could reduce the spending of the business as a whole.
For example, if the business has to account for expenditure on new technology, such as transformer models (What is a transformer model? Click the link to learn all about them.), a profitability analysis can help business managers work out which tools are vital for the success of the business and which the business could thrive without.
How Does Project Profitability Analysis Help Businesses to Align Their Strategic Goals?
Now that we’re familiar with how a project profitability analysis works, it’s time to go over some other important metrics that can be used to help businesses align with their strategic goals.
Rate Realization
Rate realization is a concept that compares the amount of time spent on projects with the amount of time that a business can charge for its services. As a sum, rate realization looks like this:
Rate realization is particularly useful to businesses that provide services, such as a construction company. For example, it could be used if a business wanted to work out how long their employees are performing a billable service (i.e., construction, etc.) rather than non-billable time spent preparing or gathering resources.
In the case of a construction business, this non-billable time would include things like how long employees spend travelling to the construction site or the amount of time spent picking up building materials. Reforming strategy in this department would help the construction business reach optimal cost management.
If a business has a low rate realization, they might want to consider switching to a closer supplier or looking to increase the share of business in the local area to reduce travel time and increase efficiency.
Return on Investment
Return on investment (or ROI) is a sum that allows businesses to work out how much profit has been generated after an investment. A good ROI for a new business would be anything between 7% and 10%. To work out ROI, businesses should apply the following sum:
This sum is crucial for business strategy, since it allows business managers to measure how successful their expansions are. Furthermore, if a business has a good record for generating an impressive ROI, they can use this data to attract investors and communicate project milestones.
Project Profitability Index
By creating a project profitability index (PI), businesses can get a glimpse into whether or not future projects will be profitable. Clearly, this is essential for business strategy, as a well-calculated PI can provide serious insight into whether a given expansion will help or hinder a business. A strong PI would be somewhere in the region of 1.3 or 30% profit margin.
The sum for PI looks like this:
If the total of the sum is greater than 1, the expansion has the potential to be profitable. On the other hand, if the total is less than 1, it won’t be profitable. It’s important to remember that no project runs exactly as planned, so it’s important to aim for a PI score that will give your project some wiggle room should you encounter unexpected costs.
Final Thoughts
Overall, by performing regular project profitability analyses, businesses can get a greater idea of how and where they’re generating costs and profits. This is essential for business strategy as it can help managers make decisions that will grow the business and help it adapt to the times.
Furthermore, profitability analysis metrics can be used to help businesses measure the efficiency of their services through rate realization and the viability of both current and future expansions through PI and ROI calculations.
These tools undoubtedly give businesses the edge when it comes to reforming strategy and driving growth, helping to build long-term stability.