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You’d be surprised just how many clients we speak to who struggle to bring together all the inputs required for effective project accounting.
Το run your agency successfully, you’ll need insight on the following questions:
- Did you make money on a project, client, or other specific segment of work?
- Which clients, projects, or types of work are driving more or less profit than others?
- Where are you going over or under budget relative to estimates?
- Which projects are at risk of going over budget?
If you want to have consistently accurate answers to these questions, then you need to refine the ways you measure performance and profitability.
What is project accounting?
Project accounting is a method you can use to gain retrospective insight into the performance of projects by tracking costs (time, materials, other expenses) and comparing them to estimates.
It can be a complex and costly process. But, done right, it can get you the information you need to make data-driven decisions and better understand where business opportunity lies.
How does project accounting work?
The process of project accounting follows the project’s lifecycle and focuses on the financial aspects:
- Planning: The project budget is created for each project, outlining the estimated costs and resource allocation.
- Execution: As the project progresses, organizations track and record actual costs, including time and materials. Agencies may recognize their revenue based on a “percentage complete” indication of a given project (usually by a milestone or stage of completion). Time spent by employees or contractors on the project is tracked, too, along with associated expenses.
- Closure and debrief: The business analyzes financial performance by comparing the actual costs and revenues to the budgeted amounts, which provides insights into project profitability and cost overruns. When the project is completed, you finalize financial records, and document variances between estimated and actual costs.
This process helps organizations gain better visibility into project finances and make informed decisions for future projects.
Using accounting systems for project accounting: A quick overview
The most common methodology for installing project accounting processes leverages existing accounting workflows and tools, such as Quickbooks or Xero. This is to avoid duplicating work and align project reporting cycles with financial reporting cycles.
The key to effective project accounting is being able to allocate revenue and costs to specific projects. This often means adding project metadata in the form of a project name, or, better yet, a unique project code or project ID to the following accounting inputs in your systems:
- Expectations:
Budgets
Contracts, SOW and agreements
Change orders
Cost estimates & forecasts - Income:
Invoices
Purchase orders
Payments
Refunds and adjustments - Expenses:
Receipts and documentation of project-related expenses, such as travel costs, equipment purchases, materials, subcontractor fees, and other direct project expenses.
Payroll allocations and/or time-tracking data for direct labor
There are two ways all of this information typically comes together for reporting purposes in the accounting system:
1. Dedicated project accounting features in accounting software
Most popular accounting software like Quickbooks and Xero have built-in features to help attribute income and costs to specific projects or jobs. If your project accounting workflow aligns with the way these features work and doesn’t require a lot of customization between projects, using these built-in features is likely the right approach for you.
2. Using alternative factors in accounting software
If the pre-built project accounting features don’t align with how your finance team needs to get things done, you need a more ad hoc approach. You may not have an efficient way of getting your time-tracking data in the accounting system, or perhaps the way you are accruing revenue and expenses conflicts with how information is organized in the project accounting software.
In cases like this, your finance team will need to identify another “object” in the accounting system. They’ll use that to specify which project to attribute a given expense to so they can report on it on the project level. The most commonly used object we’ve seen has been classes in Quickbooks online or tracking categories in Xero.
These are just two of the more common implementations but are not the only ones. Some agencies choose to do project accounting completely outside their accounting system, use third-party applications connected to their accounting system, and everything in between.
If you’re using Float’s project planning software, for example, you can easily track billable hours worked and get accurate budget tracking for labor costs. Float will even flag overtime on your team’s schedule, so you can act before the budget gets out of hand.
Determining the right project accounting implementation and workflow for your agency will require sitting down with your project and accounting teams to consider the workflows behind how each of the inputs required is created, captured, reconciled, and reported.
Three common mistakes in project accounting
In our years of experience helping agencies answer important questions about project performance, we’ve seen three common mistakes that come up over and over again as it relates to project accounting:
Mistake #1: Trying to measure net profit on projects
Many agencies attempt to measure net profit on a client or project basis. At first glance, this seems like a logical thing to do, but we find it’s actually a flawed way of measuring project performance. It adds a lot of unnecessary cost and complexity to the project accounting workflow.
Attempting to measure net profit forces the inclusion of constantly changing variables that have nothing to do with an individual segment of work when it comes to calculating its profitability. For example, agencies will try to attribute shared delivery expenses or overhead expenses to a client or project, despite the fact that neither of these expenses changes in relation to that project. If you continue to monitor project profitability on a net profit basis, you’ll get consistently inconsistent numbers—any changes in indirect costs will skew your numbers.
A better practice:
Rather than measure net profit on a per-project basis, a much less expensive and far more accurate alternative is to focus on delivery margin (which you may think of as gross margin or contribution margin). You can then set targets for delivery margin that account for overhead, shared delivery expenses, unutilized delivery time, and project overages as broader averages.
For example, you may work backwards from a net profit target of 25% to a delivery margin target on a per-project basis in the following way:
- Net profit Target: 25%
- % of agency gross income spent on overhead: 30%
- % buffer from project to P&L delivery margin: 15%
Delivery margin target: 30% + 30% + 15% = 70%
Mistake #2: Inaccurately attributing labor costs
Too often, agencies aren’t attributing labor costs to projects correctly. Rather than attributing costs to a project based on hours worked, they’ll often make the mistake of allocating payroll to projects for a given period. This means that utilization rates now also have an influence on the measure of project profitability.
This is problematic for the same reason that trying to spread overhead across projects doesn’t work. If fluctuations in utilization influence the cost of a project, it makes it more difficult to understand if a project has fundamentally gotten more or less profitable and why. It also makes it impossible to compare projects to one another as utilization will vary across time.
It’s another case of having an unrelated factor influencing agency profitability. It’s also significantly more expensive to measure as it requires constantly changing allocations or cost rates.
A better practice:
The correct way to do this would be based exclusively on time logged to the project, and the ACPH (average cost per hour) of that time. Attribution of ACPH can be done broadly (at the agency level) for the simplest and least expensive measure, but can also be more precise (by team, role, department, or by individual).
Mistake #3: Inaccurately using accruals
Accruals of expenses and revenue are often done in a way that doesn’t reflect when revenue is earned or doesn’t align with when revenue and expenses are recognized. For example, relying on invoicing schedules isn’t a perfectly accurate measure of when project revenue accrues.
This isn’t as big of an issue if project accounting is used purely for retroactive reporting—but it’s a critical factor for agencies trying to get real-time insights or for those using a form of cost performance indexing (CPI) to forecast outcomes and identify risks.
For CPI, there are generally four models to determine project completion percentages for the purpose of accruing revenue and expenses:
- Time vs Timeline
If we’re 5 weeks into a 10-week project, we’re 50% complete. - Time vs Budget
If we’ve used 500 out of 1000 total hours, we’re 50% complete. - Task Progression
We’ve completed 500 out of 1000 story points or “tasks” therefore, 50% complete. - Subjective Input
A project manager's discretion of how close we are to completion.
These all come with their own tradeoffs, so the correct methodology will largely be determined by the nature of the work your firm does. In any case, make sure you’re consistent with how you use accruals to get the most accurate results.
The downside of project accounting
Aside from avoiding the common mistakes above, project accounting is generally only useful for retroactive analysis of project performance and can be quite costly. This is because of two factors:
Complexity
Achieving the right level of complexity in an accounting system can be very expensive, both in terms of time, operational complexity, and investment in bookkeeping and accounting resources. It requires ongoing attribution of all of these costs and revenues to specific projects and creates a constant requirement for almost every transaction and invoice in an accounting system to contain structured data about the segments of work you’re trying to measure the profitability of.
All this complexity has a tendency to extend reconciliation periods—which in turn means the lag time between a project being complete and the team getting insight into its performance can get even longer (often several weeks).
Scope
Project accounting methods are asking accounting data to do a job it’s not really well suited for. The first priority of accounting is to comply with regulations and standards for tax and financial reporting. The very precise, and often arbitrary, constraints imposed on accounting data by those regulations and standards often directly conflict with the requirements of internal stakeholders. This is especially true when it comes to the data (and timeliness) they need in order to make strategic decisions.
Trying to use accounting data for strategic reporting often creates a lot of complexity and tension. It pulls the accounting team (and their tools, data, and workflow) away from their primary job and may even pull many financial professionals out of their core competency.
So, what alternatives to project accounting can we use to get more specific and timely insights into project performance without complicating or relying on our financial data?
The answer lies in the operational data your team creates every day.
A different approach: Three effective metrics
In our experience, most operations and project management teams at agencies want more frequent and specific insights into their work that aren’t bottlenecked by the finance team. Here, we’ll share some of the simple and cost-effective alternatives to traditional project accounting.
The beauty of these metrics is that they can all be measured from three simple inputs, which are all within the operations and project management team’s purview: projects, people, and time. These inputs and metrics don’t need to flow through the accounting team’s system and are easier to report to the wider team.
Let’s dive into the key metrics you can use to measure project performance without accounting data:
1. Average billable rate (ABR)
The first metric you can measure is your average billable rate (ABR), which uses your AGI (agency gross income) and delivery hours. This metric asks the question: “For each hour that my team worked on this project, how much revenue was generated?”
It’s by far the simplest and least expensive way to get insight into which clients, projects, departments, products, service lines (or any other segment of work) are more or less efficient at earning revenue.
ABR = AGI (Agency Gross Income) / Delivery Hours
Example:
The service offering that includes development has a lower ABR, meaning that you generate less revenue per hour. The exact same thing could be done to compare clients, service lines, departments, you name it.
Let’s look at one more example, comparing two clients that went through the same service offerings at the same price.
You’ll notice some clients are more profitable than others, prompting conversations about why that might be, and if revenue replacement is a tactic you may want to consider to replace them with a better-fit client.
2. Estimated delivery margin
If we want to get a bit more precise, we can start building on ABR as a way to estimate our delivery margin for any segment of work we want to measure. All we need to do is introduce an average cost-per-hour (ACPH) for that same segment of work in order to unlock a more detailed approximation of profitability and performance.
Estimated Delivery Margin = (ABR - ACPH) / ABR
ACPH can start as simple as an agency-wide number, or be as precise as a weighted ACPH based on the ACPH of each employee who worked on that segment of work.
Let’s go through a few examples of how to use this metric to answer important questions:
Scenario: How much should we charge?
If you’d like to hit a 70% Delivery Margin…
70% = (ABR - $56) / ABR
ABR Target = $186.67
You’ll need to maintain a $186 ABR based on the estimated cost in order to achieve your delivery margin target.
3. CPI (Cost Performance Indexing)
Cost Performance Index (CPI) is a great way to get in-progress insights on projects and identify which ones are at risk of going over or under budget before it’s too late.
CPI = Earned Value (EV) / Actual Cost (AC)
The resulting CPI value indicates whether the project is under budget, over budget, or on budget based on its current state.
- If the CPI is greater than 1, it means the project is doing better than planned and is under budget. In other words the project is getting more value for each dollar spent.
- If the CPI equals 1, the project is on budget. If the CPI is less than 1, it means the project is over budget and not meeting cost expectations. In other words, the project is spending more than planned for the value it is achieving.
Scenario: Is my project at risk?
Consider a scenario where you’re trying to figure out which projects are at risk, so you can prioritize. How can you figure out if a project is at risk? Let’s use a $10,000 website design project with a 100-hour budget as an example.
How much value have you earned in the project? In other words, how far along are you? This can be done in a few ways, but the more complicated way is doing this based on financial numbers (revenue and cost). In this example, we’re going to use the simpler methodology, which is using hours.
Let’s assume your project management team has determined that the project is 50% complete.
EV = Budget * % Complete, so 100 * 0.5
EV = 50 hours
What this means is that by this point in the project, you should have used 50 hours.
Actual Cost
Now, how much have you spent on this project? Use actual numbers from your timer data or time tracking system, and ACPH numbers from your people data.
Rob, Jr Designer = 15 hours tracked
Rita, Sr. Designer = 35 hours tracked
Tino, Project Manager = 6 hours tracked
Total = 56
Now we’ve got our actual cost of 56 hours, so let’s plug it into the formula:
CPI = Earned Value (EV) / Actual Cost (AC)
CPI = 50 / 56
CPI = 0.89
With the CPI below 1, we can see that this project may be at risk of going over budget.
You can use CPI to run regular reports across your projects to identify which ones need the most attention, for example:
In a situation like this, you might want to prioritize getting back on track with Project 2.
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Insight on project performance should be easy to get to
When pursuing insights on performance, remember that precision doesn’t necessarily equate to accuracy. Often, the simpler way of measuring things can provide just as much accuracy in terms of informing decisions and insights with a fraction of the cost.
While project accounting is the more popular solution, it can be costly and time-consuming. It involves complicated calculations and assigning costs and revenues to specific projects. This can be cumbersome to implement and distract your finance team from their primary focus, which is ensuring your accounting data is compliant with regulatory and reporting requirements.
Instead of using accounting data, agencies can get accurate answers to the same critical questions from project, people, and time data—which projects are profitable and how you monitor budgets.
By using this approach, agencies can simplify their project accounting, make smarter decisions based on data, and achieve more financial clarity and success—all for less time and effort than traditional project accounting.
