Professional Service Metrics

In the world of professional services – accountants, lawyers, consultants etc- the billable hour dominates the thinking and especially for client jobs were everything is customised to the particular needs.

Value pricing ideas pioneered by Ron Baker have encouraged some progressive firms to fixed pricing where the client has certainty and the professional firm carries the risk of excessive work being required. Some of these firms have even thrown away the time sheets which required staff to analyse their time in 6, 10 or 15 minute units and book to individual clients.

Solo Professionals

The basis of this type of business is selling your time and knowledge for money.

Since you are doing the work, contribution rates from any new jobs are high which can give you certain flexibility in pricing:

  • If work is quiet and this is a one-off, short-term job, you can reduce your rates to be ultra-competitive. Personally I’d find some excuse to discount my normal rate so that you get that established. Much better £200 an hour with a 30% discount for this job because… than establishing a rate of £140 an hour.
  • If work is busy, you can quote high knowing that if you get it, you’ll be well paid. You can also use it as a way to push up your other rates on a one-by-one basis at the time of contract renegotiations.

Normal fixed costs will be low if you work from home which helps to compensate for the feast or famine problem many solo professionals experience. What can be high – and this is certainly true in my business – is discretionary expenses for training but you can cut back easily if you need to make cost savings.

Profit therefore is closely related to revenue.

You can have a very simple Profit & Loss Account with any direct costs for work booked against specific clients revenues e.g. travel and accommodation if you charge inclusive fees or you can match the recharge against the expenses.

Cash flow will depend on your terms agreed with each client in terms of:

  • Billing cycles – do you raise your invoices weekly, monthly or when key stages are started or finished
  • Terms of payment – within 7 days of the invoice date, within 30 days etc

This combination of uninvoiced work done and time taken between invoicing and payment is often called “lockup” or “cash lockup”.

The best deal for your cashflow is to invoice before you do the work and only start when you receive payment. This means your cash flow will be ahead of your profit.

The worst deal for your cash flow is the opposite – to do the work before you invoice, have a delay between finishing and raising the bill and then waiting 90 days or more to receive payment.

Leverage Opportunities

Selling time for money can seem very nice when you first leave employment. All those extra hours you work become chargeable if you bill by the hour and if you get busy quickly, it can give you a nice boost in income.

But there is a trap.

The only ways to earn more are to:

  • Work more hours – but that probably goes against your personal objectives to work less and have more fun.
  • To charge more per hour – any client has the great habit of taking your hourly rate, multiplying by 40 or 50 hours per week and 50 weeks per year and coming up with a number which says you are potentially earning more than he or she is.

There are ways you can create leverage:

  1. Fixed pricing – clients don’t like paying on the clock because they don’t have control and can finish up with some nasty big bills. That’s give accountants the ability to fix prices with extra goodies thrown in at generous fee levels because they know most clients are not going to take up the offers but they sound good.
  2. Value pricing – can you unlink your fee to the time it takes and link it to the value (profit) you create. Tax accountants and consultants who specialise in fancy tax planning schemes can charge 10 to 15% of the tax saving. The bigger the business profits, the bigger the tax saving and the bigger the fee to the accountants for the same amount of work. Most real estate agents work on a percentage of the proceeds from the property sale. Top copywriters who create direct mail letters, online sales letters and advertisements can negotiate a fixed fee for the work plus a percentage of the gross sales which comes from the promotion – it’s a nice model for anyone who wants to introduce a performance related payment.
  3. Subcontracting/recruiting – getting others to do the work (provided quality standards are met) is a great way for any professional who has the marketing and sales side of the business cracked. (see below)
  4. One to many services – this isn’t one for professionals who give customises, confidential services to their clients but coaches and trainers can leverage their business by moving from selling hours one-to-one to selling hours one-to-many through groups seminars and group coaching sessions. Value is lost in one way because of the loss of individual attention but it can be gained by learning from and being inspired by the group.
  5. Selling information products – once a product like a book is created, it starts to generate passive income provided it sells and promotes your other, more expensive services.

Fixed value pricing gives you the option to tilt the payment terms in your favour by collecting one twelfth of the annual fee as a monthly retained payable by direct debit straight from your clients’ bank accounts. I’ve seen plenty of accountants do this and it makes a huge difference to their cash flow since much of the accounts preparation and the tax compliance worth is done after the end of the financial year/fiscal period.

Old – do work in months 17 & 18, bill when finished, get paid in month 20

New – bill in instalments in months 1 to 12 and get paid immediately, do work in months 17 & 18.

Professional Firms

In this situation you own a professional service firm with employees and/or contractors or you are a partner or joint owner in such a firm.

There are two issues:

  • Increasing profit and cash for the firm
  • Your share of the profit – this will be government by your partnership agreement or shareholders/directors agreement. I recommend getting legal advice before you commit to going into business with anyone so you have set procedures to deal with certain situations. Much better to get everything agreed in advance.

I’m going to be concentrating on issues involved with increasing profit for the business.

Understanding the difference between contribution and revenue and variable and fixed costs is essential to make sure you don’t get the wrong impression from any financial reports.

Revenue from your own time – this is all contribution unless you have a strange deal where you are allowed to take a fixed percentage of the money out of the business as your personal earnings/salary.

Revenue from your employees time – you have two choices, either you treat their costs as fixed and therefore the fees are all contribution or you transfer a proportion of their time from fixed to variable as a direct cost of sale.

Imagine you have one staff member – a junior consultant you pay £4,000 to each month including add-on payroll costs – at four weeks per month and forty hours per week, that makes his cost £25 per hour.

He works 60 hours in the month for client A and you charge out his time at £60 per hour –  a total of £3,600.

Under option 1 – his costs are fixed, his element of the Profit & Loss Account is:

Sales & Contribution £3,600

Fixed Costs £4,000

Loss for the month £(400)

Under option 2

Sales £3,600 (60 hours at £60 per hour)

Direct Costs £1,500 (60 hours at £25 per hour)

Contribution £2,100

Fixed Costs

Salary etc £4,000

Less recharged as Direct Cost £1,500

Net fixed costs £2,500

Loss £(400)

The top and bottom lines are the same but the make up in between is different. Option 2 makes it clear that the problem is that the problem is not enough chargeable work and not a productivity issue with the employee or a profitability problem with the customer job. Each has its advantages and for break even analysis I’d go with option 1 with a supplemental measure to show the spare capacity either in hours, % spare or potential revenue. For customer profitability purposes I’d go with option 2.

The cost allocation is simpler with outsourced contractors. Usually there is a direct relationship between them doing the work so their costs are variable to the job and reduce revenue to create contribution.

Some jobs will have a mix of your work, your employees and outsourced staff so I’d focus on contribution per limiting factor – probably your own time.

Cash issues for professional service firms are similar to solo professionals for debtors/accounts receivable and work done not invoiced. Your employees and subcontractors bring in their own cash dynamics. Both may need to be paid before you collect the cash from your client, creating extra pressure on your cash flow.

Leverage Opportunities

As for the solo professional.

Once you’ve recruited your first employee or outsourced contractor, it gets much easier mentally to add more and physically since you’ll have created procedures. Maintaining quality is essential so you need to monitor new people very carefully to make sure things are as you want and you may need to be ruthless at weeding weaker people out in the trial periods.

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