Financial Analysis – Utilization
Utilization is a key performance metric that many leaders use to understand how well their team is performing. Senior Manager Dave Van Damme discusses some less obvious utilization considerations, along with practical examples. Watch to learn more.
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Today we will discuss some specific KPIs or key performance indicators that can help you track and measure company performance.
To learn more, check out the videos throughout the series.
In a prior video, we mentioned revenue per employee should be analyzed in concert with utilization. Specifically, in that video, we examined two peer engineering companies and reasons for why revenue per employee might vary from one company to another.
Here shortly I’m going to build on an analysis from that video. But for starters, let’s get you familiar with the concept of utilization. To explore this, we’re going to look at one employee of an electrical engineering facility, a control system engineer. That employee had 1,500 hours billed to work in the past year.
The general work year consists of 2,000 available hours. Therefore, that employee was billable or utilized 75 percent of the time. And how did I compute that? Well, I looked at the total hours worked, or hours charged to jobs and divided that by the total pool of available hours. And what does that compute? Well, time spent on billable projects.
So, let’s expand this analysis to see why reviewing this might be important. We will do so by adding in a second employee of the electrical engineering facility and comparing the results of the two.
So, the second employee had 1,000 billable hours. They’re the same pool of available hours of 2,000 hours. So that would mean the employee No. 2 was utilized 50 percent of the time, or 1,000 billable hours divided by the 2,000 total available hours.
Remembering the first employee who was utilized 75 percent of the time in comparison. What does it mean? Well, starting at the most basic level of analysis, you could say employee No. 1 was simply more productive than employee No. 2 because their utilization was higher.
They spent more time working directly on a project that was billable to a customer. But stepping back and armed with some insight as to actually what the employees worked on throughout the year, you can begin to make some analysis and judgment calls as to, does this data make sense? Does, for example, it indicates an allocation matter? Was employee No. 2 asked to work on more administrative non-billable work thus causing their ratio to be lower or was their time not properly captured resulting in a loss of billable hours? Meaning, did you expect them to have a similar result, not a 75 versus 50 percent, and now the data shows otherwise?
Looking at this and this level of detail, you can begin to see and identify potential issues or changes that need to be made to your strategy.
What about a company-wide comparison though? Well, let me bring back some figures you might be familiar with from the revenue-per-employee video to show how we can look at this from an entity to entity comparison.
So, from that video, we had two electrical engineering companies, company A, company B. Company A had $6 million in revenue. Company B had $9 million in revenue. They both had 40 employees and that computed $150,000 of revenue per employee for the first company, $225,000 for the second company.
Based upon them both having 40 employees, that would mean that they had an available pool to work of 80,000 hours. And we find out further that the first company billed 48,000 hours to projects to generate that $6 million in revenue, and the second company billed 76,000 hours to generate their $9 million in revenue.
So, with that, we find out that company A had utilization of 60 percent, and company B had utilization of 95 percent. Again, just like in our revenue-per-employee video, at first glance, we might continue to say well, company B just looks better. They had the higher numbers in this.
Ninety-five percent utilization compared to something lower and $225,000 in revenue per employee compared to the 150,000 and yes, I agree. In general, the higher these figures are, the better. But be careful. Make sure you ask and answer some of the following questions or identify some of the following levers that can be pulled to give a more in-depth look first.
For example, is there an imbalance in overhead? Is our 60 percent utilization company A due to a result of a significant number of non-billable employees or which company utilizes their wage expense most efficiently? And a way that you can look at that is by computing and analyzing the average labor rate per hour, which we will touch on in a future video in the series or even bigger picture. Which entity is doing the right work?
Meaning the results of our analysis could actually point in a different direction from what we’ve been talking about all together when looking under the hood.
Potentially company A is actually being more thorough in their contract selection process, accepts a lower utilization because they intentionally want to bench employees in order to have resources allocated to go after new, more profitable opportunities.
So, it could be that company A actually has the competitive advantage in our analysis. How do we discover answers to any of the questions that we’re posing here? Well, it takes further analysis, and we’re going to address some of these in a future series where we will explore concepts such as realization and revenue-per-billable hour.
But for now, we will actually jump in, in our next video and start talking about gross profit and gross margin, which will shed some light on some of the questions we’ve discussed here.
To summarize, utilization allows you to uncover and see not only how utilized your human resource capital is but the quality of that utilization when compared to other measures. It’s computed by comparing billable hours against the total pool of available hours.
Let us know your thoughts and thanks for watching.
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This content was also published on the Control System Integrator Association website.