Cost Template Ground Rules.
We follow a Standard Cost Template to develop the standard cost for job costing, and calculate of the re-class from COGS to OpEx for non-member professional staff. For 2017, the intention is to generally use one rate (on T&M projects) for each staff member, with the goal being to keep it simple and to represent a reasonable interpretation of profit and loss by job. In considering this approach, be aware of other opinions; however it’s smart to use a standard and stick with it unless there are extreme circumstances such as a significant difference in bill rates from the assumption. Such as, working on a project at $300/hour. The reason for this is:
1) Determining the actual cost of a billable hour, depending on your tolerance level is impossible in advance for any staff that will hit the FICA CAP, the WC CAP, the 401(k) CAP and/or is on Medical.
a. For example, below the FICA CAP, the cost is 6.2% higher than after the CAP. The general goal of a standard system is to determine a predictive cost factor for resource consumption over a reasonable period of time, generally an operating cycle.
2) In the same way, the 401(k) match can’t be determined in advance. If an employee defers zero for six months, then 10% for six months, they still get the 4% match, so should the hourly cost for the first six months be lower than the second six.
3) Looking to balance the value of the information with the complexity and cost to get the information leads me to want to use the single rate (again, in virtually all circumstances) and we recognize that any standard cost for an employee is an estimate.
4) In the end, this is about cost allocation, not expenditures.
Distortion Effect. The Gross Margin Dollars and Percentages for the firm as a whole are not impacted by the standard cost for billable work. They are influenced by transfers from COGS to OpEx in developing the internal rates. You can allocate PTO costs entirely to billable work since this staff is not primarily engaged for non-bill work.
Different Billing Rates Effect. Since we don’t always bill the same staff at the same rate the use of a single standard will likely have some level of distortion. For example, a CFO that has an expected billing rate of $215/hour for the year and a 60% split on jobs where the actual bill rate was $225, the job would be under costed (for the CFO time) by around $6.60/hour or around 3% of revenue. Assuming there is more than CFO time on the job, the overall margin indication would more than likely be less than that on a percentage basis. The review guideline we recommend is jobs under 25% (after commissions) and jobs over 35% (after commission), so basically anything within that range is deemed analytically reasonable.
The above is not to say don’t set your rates to deliver the minimum margins overall. You should make sure splits and commissions are correct and then transact them. From job-by-job profit assumptions even the best cost accounting is not perfect and the right answer is the one that is materially correct at the lowest possible cost to compute and maintain.
Absent a lot of no charge and or discounts it is idea is to examine the outliers and not concern yourself with small percentage differences. For example, if you are paying your staff 60% splits your margins are going to be around 30% to 34% before selling costs, maybe a bit higher with use of Independent Contractors. There is no need to determine if a job was 31% or 34%. At the end of the day, the percentage is not nearly as meaningful as the dollars generated to the company.
In the same way, the concept of gross profit by employee should be determined (if it needs to be determined) by taking:
(Total Revenue Generated by The Employee) – (Total Cost of The Employee) = Gross Profit by Employee
This is also a good time to check with your software provider to see if you can have a standard cost rate (static) on a project by project basis. If we can, that would certainly reduce the distortion of using just one standard per employee.
To learn more about the PBO Standard Cost Template and other ways PBO can help you, please contact us at 858.622.1681 or email@example.com.