Standard Cost & Gross Margin in Professional Services Organisations

We’re all familiar with the concept of a gross margin and standard cost in a trading or manufacturing organisation. Goods cost money, whether you’re buying them or making them, and it’s not too difficult to calculate them – in the case of traded goods it’s a matter of adding together purchase price, transportation costs, duties, and other costs associated with getting them into your warehouse, and in the case of manufactured goods it’s a matter of calculating the material costs, labour costs and overhead costs that go into the components and final product you’re making. domain mentions Very often it’s convenient to work with standard costs so that you can forecast your gross margin and then monitor variances – those things that go wrong or right that make your costs higher or lower – higher transportation costs, lower labour costs, higher overheads, etc.

But what about costs when it comes to professional services? In this case we’re not considering materials, but rather the cost of the people you’re employing.

What I like to do is to calculate a standard daily or hourly cost for each employee engaged in chargeable work so that I can then forecast a gross margin and retrospectively analyse gross margin on projects by client, by department, by team, and so on.

How can we calculate a standard cost?

I first calculate the total number of days available for chargeable work. I count the working days in the year (weekdays minus holiday allowances, minus public holidays, minus planned training days and perhaps a day or two for sickness). Then I estimate the number of these days that I would expect to be devoted to chargeable work – applying a utilisation factor (say, 75%).

For example:

365 days in the year –  104 weekend days – 20 days holiday – 5 public holidays – 2 sick days – 5 days for training or company meetings = 229 days.

Assuming 75% utilisation, this means that I expect 172 days of chargeable consulting.

Then I take all direct costs for an employee, including salary, taxes, insurance, directly assigned equipment, car, training, etc.

The I calculate a standard cost as this total cost divided by 172 chargeable days.

I also like to monitor variances that arise if direct costs are different, or utilisation is different.

But, it’s useful to have a rough picture of the gross margin of projects. I like to see a project P&L that shows:

  • Fees at standard cost
  • Fees at negotiated cost
  • Giving – Variance on fee rates
  • Standard cost
  • Giving – Gross margin

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