These, I think, are six important financial KPIs that a professional services organisation must monitor:
Measure No. 1 – Utilisation
Measure No. 2 – Standard Fee Variance
Measure No. 3 – Activity Variance
Measure No. 4 – Realisation
Measure No. 5 – Standard Cost Variance
Measure No. 6 – Work in Progress Days
I recommend two more, two that are somewhat less exciting, but always important whatever kind of organisation you’re running. If you don’t watch them you might founder.
- Measure 7 – Overhead Variance
- Measure 8 – Debtor Days
In fact, little needs to be said about overhead variance, since determining this by comparing actual costs against budget for all costs that are not specific to the exercise of professional skills, is no different in a PSO than in any other kind of business.
The cost of all staff in a PSO will often amount to between 60% and 80% of operating costs. Controlling these costs is proportionately more effective than controlling overheads, unless these are clearly extravagant.
Only one note is perhaps worthwhile here and that is to stress the importance of attributing costs, where possible, to clients and projects. Entertainment, travel, and other costs associated with client and project management, even if not recharged directly to clients, should be attributed to clients, so that the real cost, and margins associated with clients and projects can be known, and the remaining unattributed overheads understood separately.
Debtor Days is a measure common to all businesses, but bad or merely overdue debts are as likely to destroy the financial health of a PSO as any other kind of business. All other indicators may be healthy, but if this indicator is ailing, then your business may still be in trouble.
How is Debtor Days defined?
Debtor Days is a measure of the number of days of revenue required to cover the current debtor balance.
It is calculated as:
Debtor Days = ((Debtor Balance / (Average Monthly Revenue * 12)) * 365)
Average Monthly Revenue may be calculated based on the previous six or more months’ revenue.
For example, if your Debtor Balance is 120,000 and your average monthly revenue is 60,000, then Debtor Days = ((120,000 / (60,000 * 12)) * 365) = 61 (approximately).
In this example, your company must work for two months to cover the cash that is owed to your organisation by your clients.
Note that Debtor Balance may include a tax component (e.g. VAT or GST).
Debtor Days compounds the issue of WIP Days. Adding Debtor Days to WIP Days tells you how many days or months of work you are financing. In many PSOs direct costs related to staff (and not just professional staff) can amount to 80% of the company’s monthly costs. These are costs where payment cannot be deferred without serious risk to the business.
Debtors are rarely eager to part with cash, and most organisations have a well-rehearsed approach to debt collection, involving the usual techniques of polite coercion, dunning notes, the suspension of services, and the threat of legal action. These methods are best left to specialists in the finance area, whose insistence will not undermine the (often apparently uncommercial) relationship that a consultant or project manager might have with his or her client.
However, it is important is to understand what bad Debtor Days means in a PSO, besides a reluctance to part with cash. And whilst you might want to protect your professional staff from the issue of non-payment, it is important to involve them in the issue when it become serious or when it is inexplicable, since non-payment may very well reflect the client-consultant relationship, about which they know the most.
- Ensure that contracts explicitly provide for termination and suspension of service in the case of non-payment
- Ensure that contracts stipulate appropriate procedures enabling clients to challenge invoices, as well as enabling you to challenge non-payment, and that the conditions for triggering these procedures (as well as when the right to make such challenges expires) are clearly stated
- Structure your contracts in such a way that you cannot be exposed to bad debt and the risk of non-payment beyond a certain well-defined level. This might involve breaking a project down into phases or stages that are relatively small. In addition you might agree a credit limit for the project, the breaching of which will trigger suspension of services. This credit limit might also be variable (ideally declining) during the course of the project.
Thoughts on Measuring and Managing Professional Services Organisations – Adam Bager