How To Measure Project Profitability And Improve Margins

Profitable projects are the lifeblood of many service businesses. You’re supposed to take on new projects to grow, but why are they stalling your growth?

Profitable projects keep professional service businesses alive.

Yet, measuring and increasing project profitability is a daunting task for many. The good news is that there are proven steps you can take to increase the profits of your projects, and we’re going to cover them in this article. 

You’ll learn:

• How to measure project profitability
• What project profitability analysis is
• How to increase project profitability in six steps 

Let’s dive in. 

What is project profitability?

Project profitability is a metric that measures how much money a project makes. 

It is calculated by subtracting all project expenses, including labor, materials, and overheads, from the generated revenue. The resulting number is the profit. 

Simply put, if a project brings in more money than it costs to complete, it is profitable. 

Let’s look at an example of how an agency might measure project profitability. 

The agency takes up a project for a client and agrees to a fixed fee of $10,000. 

Let’s assume that this project costs $7000 to deliver. The costs include:

• Team salaries and benefits
• Cost of tools and licenses
• For in-office teams, rent, infrastructure, and utility costs might add up
• Customer acquisition costs (if considered by the agency)

Project profitability = Revenue – Costs 

Thus, the profits from this project are $3,000.

The above example is straightforward. Measuring project profitability precisely takes some work which we cover further down in the article. 

Why is it important to track project profitability?

Here are a few reasons why tracking project profitability matters, whether for fixed costs or time and material projects.

Fixed cost projects:

• Budget management: Tracking profitability helps businesses ensure the project stays within the agreed budget and avoids overspending. 
• Pricing strategy: It helps companies evaluate their effectiveness, cover costs, and generate profit. 
• Financial planning: By having insights into the project cost structure and profitability, you can plan similar future projects effectively. 
• Financial health monitoring: Tracking project profitability helps you monitor how financially healthy your business is and ensure you can invest in future growth opportunities. 

Time and material projects:

• Billing accuracy: Tracking time and material project profitability helps bill accurately based on the actual time spent on the project. It also enables you to optimize your billable rates.

• Informed decision-making: With the right profitability insights, you can steer projects in the right direction and ensure they align with your financial goals. 
• Efficient resource allocation: By understanding which projects are most profitable, you can allocate resources more effectively to maximize your return on investment. 
• Identify project issues: When tracking project profitability, you can spot potential problems early on and get a project back on track if it’s not meeting its profitability goals. 

What metrics can I use to measure project profitability?

Below are essential profitability metrics that businesses consider when tracking project profitability.

Gross Margin 

Gross margin measures the difference between the revenue generated by a project and its costs. This metric helps businesses understand how much profit a project makes before considering indirect costs, like administrative expenses. 

Net Profit Margin

Net profit margin considers a project’s direct and indirect costs to show its actual profit. This metric provides a comprehensive view of a project’s profitability. 

Return on Investment (ROI)

ROI calculates the ratio of net profit to the initial costs of a project. It shows how much profit each dollar of investment generates and helps businesses understand their project investments’ efficiency.

Realization Rate

This metric focuses on the billing aspect of projects. It measures the percentage of billable work hours billed to the client. The realization rate tracks how efficient billing practices are and if a business captures all potential revenue. 

Utilization Rate

Utilization rate measures the percentage of billable hours out of the total available hours.

Businesses track this metric to improve productivity and increase profitability by optimizing billable hours usage. 

How do you measure project profitability?

Here’s a step-by-step guide on how to efficiently measure project profitability:

1. Calculate your profit margins

Profit margins are the measure of the profitability of a business. They represent the percentage of project revenue a business keeps as profit after accounting for all of its costs.

1. Gross profit margin

Gross profit margin is a metric that reflects the profitability of a company’s core business activities, excluding operating expenses.

It shows how efficiently a company generates profit from its service delivery processes. A higher gross profit margin implies a company efficiently converts revenue into profit. 

For a fixed-price project, the gross profit margin is straightforward. You subtract project expenses from the fixed revenue amount, divide by the revenue, and multiply by 100 to get the percentage. 

In time and material projects, the revenue and project expenses are a function of the billed hours. 

Gross profit margin formula: 

For example, if an agency generates $10,000 in revenue from a project and spends $4,000 on project expenses, the gross profit margin would be: 

In this example, the agency’s gross profit margin for the project would be 60%. This number means for every dollar of revenue earned from the project, the agency keeps $0,60 as gross profit after covering project expenses. 

Toggl Track simplifies how you calculate and visualize project profitability. 

You can add labor costs, estimates, and billable rates in Toggl Track and use the Project Dashboard and Insights reports to visualize the profitability of each project. 

To add labor costs and billable rates for team members:

1. Click on Organization, choose Workspace, and navigate to the Members tab.
2. Add billable rates and labor costs in the corresponding columns by clicking on the field to edit it. 

Then, you can access the Insights reports for data trends and project profitability details.

2. Net profit margin

Net profit margin is the percentage of revenue that remains as net profit after deducting all expenses, including project costs, operating expenses, taxes, and interest. 

It shows the overall financial health of a company and how well the company manages its expenses. 

Net profit margin is calculated by dividing net profit by revenue and multiplying by 100. 

Net profit margin formula:

For example, if an agency has a net profit of $3,000 and sales revenue of $20,000, the net profit margin would be:

According to Investopedia, a good profit margin for small businesses should range from 7% to 10 %.

2. Calculate the profitability index

The profitability index is a financial tool that helps businesses evaluate the potential profitability of a project. It is a useful measure of project feasibility.

It compares the money you earn from a project with the amount you invest. 

The profitability index formula divides the present value of future cash flows (the current worth of expected income discounted to reflect its value today) by the initial investment.

Profitability index formula:

• If the index is higher than 1, it’s a green light. The project is likely to generate more money than its cost.
• If the index is less than 1, the project might not cover its initial costs, so either shelve the project or rework its budget and/or scope.
• An index of exactly 1 suggests that the project will break even, which is not a profitable scenario. 

3. Calculate project ROI

According to Investopedia, ROI (return on investment) is a key financial metric that evaluates the profitability of an investment.

Project ROI measures how much money a business makes from a project compared to its costs. 

ROI formula:

For example, let’s say you invest $1,000 in a project, and it generates $1,200 in revenue. The net profit from this project would be $200 ($1,200 – $1,000).

Using the ROI formula:

Although every business has strategic and financial goals, a range between 5% and 10% is typically considered a reasonable target ROI.

What is project profitability analysis?

Project profitability analysis is a financial assessment technique that helps companies evaluate the financial performance and potential profit of a project.

This method involves calculating the net profit or loss, considering all possible revenues, expenses, and cash flows associated with the project. 

A project profitability analysis usually considers the following factors:

• Revenue projections
• Cost estimates
• Cash flow analysis
• Risk assessment
• Scenario analysis
• Time management

In Toggl Track, you can analyze project profitability using the Insights reports and the Project Dashboard.

By accessing Insights, you get precise data on project earnings, labor costs, billable hours, and income vs expenses. 

In the Project Dashboard view, you can analyze performance and see project forecasts based on total hours tracked and estimated. 

How do you increase project profitability?

Here’s a quick overview of six ways you can increase project profitability:

Let’s look at each in detail. 

1. Track billable vs non-billable hours

The difference between billable and non-billable hours is related to direct revenue generation. 

Billable hours are what your team spends working on client tasks and projects. You put these hours on your invoices and charge the client for them. 

Non-billable hours are what your team spends on admin tasks, internal meetings, or training. They don’t generate direct income but are a cost to your business. 

A standard agency goal is to spend 75% of the available hours on billable tasks. 

Separating billable and non-billable hours lets businesses accurately analyze productivity and profitability. This visibility helps project managers optimize resource allocation and pricing strategies. 

With Toggl Track, it’s easy to track billable and non-billable hours using the online timer, browser extension, desktop and mobile apps, or integrations. 

 Here’s how:

1. Type in what you’re working on
2. Select your client
3. Find the task and project you’re working on
4. Start the one-click timer

You can mark any project or task as billable by clicking on the $ symbol at the top of the page:

Toggl Track’s desktop app can automatically record all apps and websites you use in the background without manual input. 

At the end of the day, you can review the time data tracked and choose what you want to include in your timeline. All data is 100% private to each user. 

With Toggl Track, you can set billable rates on the workspace, project, and team member levels. 

To set project rates in Toggl Track:

1. Go to Projects.

2. Click on an existing project to edit it, or click “Create new project” and add the billable rate from the Project Edit popup.

2. Identify bottleneck tasks

Almost every project has bottleneck tasks that disrupt workflows and slow progress. 

Waiting for client approvals and feedback or making revisions can lead to delays and inefficiencies.  

Here are some brief strategies to manage bottleneck tasks:

• Allocate more resources to these tasks to speed up the process.
• Train team members to enhance their skills or hire specialists for specific bottleneck tasks.
• Reallocate tasks among team members. 
• Constantly review and adjust workflows and processes to prevent future bottlenecks.

With time tracking tools like Toggl Track, you can spot bottleneck tasks early to keep the project running smoothly, on schedule, and within budget. 

It lets you set up hourly tasks and project time estimates to easily track progress and monitor actual hours compared to the forecast. 

To set project time estimates, follow these steps:

1. Click Create New Project or Edit Project
2. Scroll down to the Time Estimate section
3. Enter your custom hourly estimate

For more granularity, you can also create task-based estimates:

1. Open the Project
2. Select the Tasks tab
3. Add or edit an estimate from the Estimate column 

You can quickly overview your project’s progress from the Project page. 

See the overall number of tracked hours per project in the status column and compare it to the estimate you set. This feature tells you if your projects are on target or exceed your estimates. 

With this info at hand, you can easily spot time-consuming tasks and take action to reduce unproductive time. 

3. Make more accurate project estimates

Here are a few benefits of creating accurate project estimates:

• Easy to track progress
• Increased project profitability
• Fewer risks
• Higher client satisfaction and stakeholder confidence 
• Easier to allocate resources

You can estimate project time by using various estimating techniques. 

In Toggl Track, you can review similar past projects to create accurate estimates. Here’s how:

• Go to Reports and select Summary Report.

In this view, you can see clear insights into the time and costs of your past projects and billable or non-billable hours. 

• Use the Project filter to find a similar past project.

• See the task breakdown.

With the Project Dashboard feature, you can easily track project progress by comparing actual time tracked with your estimates. 

From this view, you can see:

• A forecast for project completion based on the project estimate
• The progress against the fixed fee amount set for the project
• Total billable amount tracked so far for the project

These easy-to-read visual insights can help you analyze your project’s performance and progress, forecast timelines and budgets, and spot potential blockers. 

4. Track your project’s profitability

To improve project profitability, you need to track it first. 

Monitoring profitability can be overwhelming without a reliable tracking system, especially when juggling multiple projects and clients. 

To calculate project profitability in Toggl Track, you must calculate and add Labor Costs first. 

Start by calculating the total available work hours in a year, usually around 2,080 for full-time employees. Then, divide the employee’s annual salary by this number to get the hourly rate.

Hourly labor cost formula:

For example, an annual salary of $40,000 results in an hourly cost of about $19. 

Once you have the labor costs for each employee, you can easily track project profitability in Toggl Track. 

The Insights Dashboard lets you view project profitability data in the graph and the table below. 

See project earnings and losses, labor costs, and billable hours at a glance, and export your Insights report in CSV or Excel format. 

This feature also helps you forecast future revenue by analyzing your team’s billable hours and expenses. 

5. Track employee utilization rate

Calculating and tracking employee utilization rates helps you understand productivity, closely related to profitability. 

The more productive employees are, the more billable work they do, which boosts your earnings. 

To calculate employee utilization rate, most agencies use this formula:

For example, if an employee has 160 total available hours in a month and spends 120 hours on tasks, that can be billed to clients. Using the formula:

Employee Utilization Rate = 120/160 x100 = 75%

Here’s how employee utilization rates can help you increase project profitability:

• Optimize work allocation: By understanding individual and team utilization rates, you can allocate tasks efficiently and balance workloads. 

Overutilized employees may be at risk of burnout, while underutilized team members have untapped capacity. Both scenarios hurt profitability. 

• Analyze productivity: Utilization rates can show project managers how productive the team is. 

A consistently high utilization rate might mean your team is stretched thin, and you may need to hire more people. If employee utilization rates are low, you might need to get more clients on board. 

Tracking billable time accurately with a tool like Toggl Track, makes it easy to calculate employee utilization rates. 

Time tracking with Toggl Track is available on the web, mobile, and desktop apps or via a browser extension. 

To separate billable from non-billable hours in Toggl Track, you need to:

1. Go to the Projects tab and click Create a New Project.

2. Mark your project as billable or non-billable.

6. Try to eliminate scope creep

Scope creep is when a project’s requirements (goals, deliverables, tasks) expand beyond its initial boundaries. Scope creep can pull down project profitability, causing budget overruns and delays.

Here are a few ways you can avoid scope creep:

• Establish clear project objectives and requirements from the start
• Create realistic deadlines and budgets
• Get key stakeholders involved in the project
• Create a detailed project scope
• Monitor project progress
• Create a risk management plan

If you want to dig deeper into what’s causing scope creep and explore tips to avoid it, read What is Scope Creep? Common Causes & How to Avoid Them.

What is the role of a project manager in the project’s profitability?

A project manager’s role in ensuring a project’s profitability is pivotal. Here’s why:

• Manage planning and budgets: Project managers are responsible for planning projects in detail and creating and managing project budgets.
• Allocate project resources: They also ensure that resources like people and materials are allocated effectively throughout the project. 
• Monitor progress and control expenses: Project managers track progress, manage costs, and adjust plans to avoid budget overruns. 
• Communicate with the team and stakeholders: They keep open lines of communication with the team and stakeholders to keep everyone aware of project goals, progress, and financial status.  
• Manage time and project scope: Project managers keep the project within scope and organize project timelines to meet deadlines. 
• Identify cost-saving opportunities: They seek ways to reduce costs without compromising quality to keep the project within budget. 
• Spot additional revenue opportunities: Project managers also explore opportunities within the project scope to generate more revenue. 

Increase project profits with the right tool

Tracking and improving project profits is much easier with the right tool. 

You can give Toggl Track a try for free to see how it can help:

• Track billable and non-billable hours
• Monitor project performance
• Calculate utilization rates
• Improve your estimates

Schedule a free demo with Toggl Track. 

Related articles:

• How to Track Project Expenses (And Stay Within Budget)
• 10 Best Cost Management Software in 2024 [Detailed Overview]