What Is Profit

When you're selling things – no matter whether it's products

or services –

you want to be selling at a profit. You want to make money at it — that's

the point of the game.

But what is profit? I've had many conversations with colleagues,

clients and friends along the lines of:

So, you're selling this widget. It costs you £15 and you're selling it

for £20. That's £5 pure profit.

Which usually means

You're trousering the fiver, so you can move a bit on your selling

price/commission rate.

Something very similar applies to project costings. The same clients, employees,

colleagues and friends tend to think that you subtract the cost of things

bought for the project (say software licensing, hosting and so on), and

the rest is pure profit.

But is that so? What does profit mean, and how do we make sure we're making

any (let alone enough)? Let's take a look.

What is Profit

Profit is simply the final amount of money that the business makes, once all

the costs are paid from income (aka Revenue). But Revenue and Cost have to go a

long, long way before what's left makes its way into your trousers.

What you're more interested in at a project level is Gross Profit.

That's Revenue, less all the things you had to do to earn it. On a software/development

project, the largest item is likely to be Labour — the amount the business

or subcontractors charges the project for use of people. But it'll also include:

• any software you license for the project/client's use
• any hardware you buy for the project/client's use
• any custom development the project requires
• any hosting/connectivity the project requires
• all costs associated with enabling the people to work on the project,
  so all travel/accommodation expenses for the project. Be careful about
  which expenses are allocated to your project, and don't get confused that
  the term Expenses is also somewhat interchangeable with Indirect Costs
  (see below).

Generally, the most controllable element is going to be Labour. The other

elements are either pre-agreed with the client or already contractually locked at the

start of the project.

What you can do though is swap people about, swapping more expensive

people for less expensive if you're over-budget, rolling people on or

off if you're behind or ahead of schedule and so on. You can also drive the

team's sense of urgency to improve time and/or cost efficiency.

Measuring Project Success

In many organisations, a PM's primary target is hitting the required level of

GP, and often, this is fixed on a company or client level as a percentage

of Revenue. Hit (or exceed) the desired GP, and you're a hero. Miss the

target, even if you deliver some GP, and you're not.

Beware - Fixed Costs Lurking

But I hear you say

What's the problem? I delivered 25% GP. I know my target was 30% GP, but I

still brought in Profit, right? So I still did well.

Well, not necessarily. Why do you think the target was set at 30%? Was it

just corporate avarice and a desire to stick it to the customer? Possible,

but unlikely.

The reason for what might seem high targets is that the project's GP has to

pay for a whole load of other costs, which are incurred no matter what the

size of the job, or whether you even do it at all.

Quick Costs Quiz

Who pays for the following:

1. Time spent selling
2. Your company's offices (premises, heating, phone, equipment)
3. Your site hosting
4. Staff salaries that aren't client chargeable
5. Training
6. Interest on Bank Loans
7. Advertising
8. Travel that's not client chargeable
9. Staff Holiday Time
10. Taxes
11. Developing new products and services

Well, the business does. And it has to come from somewhere (sadly). So if

it doesn't come from clients, where does it come from?

Your project GP has to contribute towards these costs, which

mount up every day, no matter how much business you're doing.

If you didn't spend them, sure, you'd have higher profits at the end. But

you'd seriously dent your capability to operate as a going concern. They're

fixed - there's very little you can do in the Project to affect them as you're

spending them indirectly. These costs are Expenses to the business

as a whole, rather than to your project and consist of everything the company

has to spend to develop products and services and bring them to the market.

They're called Fixed Costs aka Indirect Costs.

Now you've paid Direct Costs (leaving you with GP) and Indirect Costs, what

you're left with is Pure Profit that the business owners can now trouser.

Right? Ah, no.

Death and..?

Yes, you guessed it, Taxes. What you're left with at this point is a Pre-Tax

Income (PTI) aka Net Earnings Before Taxes

(NEBT). PTI is like your company's

salary. The Taxman

has to have his slice before it goes near anyone's trousers. Depending

on where you work, this will a be combination of any number of national and local

taxes (NB for UK people, this might not

include VAT, as depending on

how your accountant wants to handle it, it may be considered a Direct Cost

to the project).

Once the business has paid tax on what's left of the Revenue you brought in,

then – only then – can you look at the pittance that's

left and call it Profit.

Pricing for Profit

So that tidy nestegg of GP that you

delivered to the company gets chopped up many ways to pay the project and

company's costs before it can be considered Profit.

This might be visible to you, so at the end of the year or project,

your (on-target, right?) GP takes a

big charge for Indirect Costs (this is called Accruals). Or it might be

invisible - so you just deliver your GP to the company, and it all

happens behind the scenes. Either way, you are contributing to

those costs, so your initial pricing had better reflect those costs.

At the start of this article, you may have thought something like 30%

Pure Profit? That's extortionate! Hopefully now, you'll see it as something

more realistic. When you set your target GP

for a project, you need to have an understanding of all the Direct and Indirect

Costs that the project will need to bear. Once you understand the true costs,

you're in a much better place to set a realistic price that leave the company

ahead of the game at the end.

But I hear you say:

But my clients won't pay prices that include such a high

GP.

Might I respectfully suggest that you're working with clients who either

don't understand or (worse) don't care that you make enough to stay in

business? Hopefully the above will give you ammunition for your negotiations.

If you're doing small numbers of large projects, chances are that you're sharing the

Indirect Costs around more thinly, reduce the proportion of non-chargeable

staff time and take less management overhead than large numbers of small jobs.

So it's reasonable that larger projects attract a lower percentage charge for

Expenses, and therefore require lower GP

targets.

Definitions

To recap all those definitions (and a few more you might hear):

Profit

The final amount remaining after all costs have been paid from Revenue.

Very difficult to calculate on a project by project basis, so a project

usually talks about Gross Profit.

Revenue

The money that you charge to customers for providing products or

services.

Costs

The total money it takes to deliver the product or service; not only

the cost of producing the actual delivery, but also having an organisation

in place to do it.

Direct (aka Variable) Costs

The actual costs you can directly associate with each item or project.

These vary with the level of activity — sell/produce/deliver

more and your costs go up. You add a requirement? You add developer

time, and that's a direct cost. Need hosting for a client site?

That's a direct cost.

Gross Profit

A project's GP is what many

people think of as profit - it's the project Revenue, less Direct

Costs. This is frequently expressed as a percentage of Revenue.

Indirect (aka Fixed) Costs

Costs you bear, whether you're delivering or not. Bank loans, admin

staff, heating, lighting, marketing & sales; they're all indirect

costs.

Expenses

An expense is what is spent to bring a product to market and sell it.

This is an indirect cost, and shouldn't be confused with expenses that

your team charge for travel, accommodation etc (these are direct project

costs). The most common type of Expenses a Project Manager will have to

bear are SG&A expenses - Selling, General and Administrative Expenses.

Overhead

Overhead is an expense that goes to maintain the organisation. This

might be management and admin staff. It's also the cost of people

who aren't directly billable, such as system quality assurance or

the operational support staff. It's equipment purchase/lease and

network connectivity. It's heating and lighting.

Burden

Burden is those expenses associated with employees. This includes

payroll taxes, benefits, and holiday. It also includes all the time

that your staff are sitting around, not earning Revenue (which is

why contractors are popular, although their rates will include an

amount to cover their Burden).

Year-end Accruals

Projects are often charged their Expenses at the end of the year –

they're all saved up (accrued) and dropped on the project in one go.

PTI (aka NEBT)

Once you've taken all your Indirect costs away from your

GP, you're left with your

Net Earnings Before Taxes (NEBT) aka Pre-Tax

Income (PTI). Take off taxes from your company's

total PTI and you have Profit - Pure Profit at last!

Bootnote

All pricing, margin and Gross Profit figures above are fictitious and arbitrary,

used simply to illustrate the points.