Monday, 25 April 2022

Management accounting of projects

 



 

 

The article is written for companies in the consulting and professional services sector.

What characterizes such companies? As a rule, they conduct project activities, and projects are aimed at creating an intellectual product or service. The main resource of such companies is employees, or rather their time and competencies. Typical examples: design bureaus, consulting companies, advertising agencies, IT integrator, audit organizations.

Management Accounting in simple words is a set of business processes for planning, accounting and displaying information, the purpose of which is to support decision-making by the company's management.


Objects of management accounting in the professional services sector:

  • It's time.
  • Projects.
  • Labour.


Revenue and costs for projects.


The specificity of management accounting in professional services is due to:

  • The project nature of the activity;
  • Emphasis on time tracking as the main production asset.
  • Objectives of project management accounting
  • Why is it important to account for project finances and maintain management records? The question is rhetorical, because the goal of business is to make a profit and professional services are no exception.


Since the company earns on projects, the profitability of the business depends on the profitability of each individual project.



As a rule, profitability is a key indicator of the project and the manager is responsible for it. Often the monetary motivation or, more simply, the bonus of the project manager and the team is tied to the fulfillment of this KPI. Therefore, the project manager needs a tool for planning, controlling and predicting the profitability of projects.



So, the first goal of maintaining management accounting for projects can be formulated as follows: to give the project manager a tool for operational control of the profitability of projects.


Such a tool can be a profit and loss statement (P& L, Profit & Loss Statement). At any given time and for any period, the manager must have a report on the current financial status of the project and its deviation from the original budget in order to make management decisions.

Let's formulate the requirements for such a report:

  • The report should be simple.
  • The project manager is not a financier or an accountant, he just needs to understand whether he gets into his KPI or not. Therefore, there is nothing superfluous - only indicators directly related to the project.
  • The report should be prompt.
  • The term of its "delivery" to the manager should be minimal. If the project goes on for two months, and the report can only be built monthly, the value of such a report for project management will be minimal.
  • The report should be isolated from external financial factors.
  • The report should contain financial indicators specifically for the project. It makes no sense to include information about the administrative or overhead costs of the business in the report for the manager.
  • The profitability of each individual project is certainly an important indicator, but there is a level higher - the level of the operating director (let's agree to call the employee responsible for the profitability of the business as a whole). The director should have a complete picture of all projects, their aggregate profitability and the profitability of the business as a whole.


Therefore, the second goal is to give the COO a tool to control the profitability of "production" as a whole.

We deal with profitability


Let's start simple. Profitability and profit in general are calculated as follows:

Profitability = Profit / Revenue

Profit = Revenue – Costs

Cost classification
All costs in professional services can be divided into direct and indirect.

Direct costs clearly relate to a specific project. For professional services, a significant item of direct costs for the project is the cost of labor, that is, the cost of labor resources invested in the project. Sometimes there are other direct costs: contractors, materials, business trips, transportation costs, and so on.

Indirect costs cannot be attributed to a specific project. Examples of indirect costs: office rent and office expenses, advertising, salaries of directors, accountants.

A simple way to determine the direct costs in front of us or indirect ones is as follows: direct costs have at least two characteristics - the project and the period, and indirect costs one - the period.

Types of costs in management accounting


Types of profitability


Depending on what costs we take into account in the calculation, we will get two types of profitability.

Gross profitability. When calculating it, only direct costs are taken into account.

Gross Margin = Gross Profit /
Revenue Valude Profit = Revenue - Direct Costs

Operating profitability. When calculating it, both direct and indirect costs are taken into account.

Operating margin = Operating profit / Revenue

Operating Profit = Revenue - Direct Costs - Indirect Costs

For operational project management, gross profit is best suited:

It is easier to understand and calculate.
The project team can only affect gross profits, in particular the team cannot affect overhead costs. Therefore, it is the gross profit and profitability that shows the economic efficiency of the project, cleared of external factors.


Accounting for indirect costs


In practice, it is recommended that indirect costs be taken into account at the level of the coo director and not be spread across projects. Example of p&L:

Example of a profit and loss statement in management accounting
An alternative option is to spread the indirect costs of projects according to some principle, for example, evenly to all projects:



Example of an income statement with indirect costs in management accounting
It is important to understand that the project team does not have an impact on indirect costs, so operating profitability cannot be a good indicator for motivation.



For example, if after the start of the project, with an already fixed budget, the company moves to an expensive office, then indirect costs rise sharply, and the economy of the project "goes into the red". But this has nothing to do with the management or work on the project, as a result of which the motivation of the team is lost, and the company's management, assessing the profitability of the projects, cannot draw a conclusion about the source of the problem - poor planning, project execution or external circumstances.

Practical advice


Determine the target operating margin for a calendar period (for example, a quarter). This is the KPI of the COO.


Determine the target gross profitability of each project. These are the KPIs of your project managers.
In the income statement at the project level, do not take into account indirect costs - this will allow you to understand the effectiveness of the implementation of each project separately.
At the COO level, build a periodic report on operating margin, taking into account indirect costs. This will show the economic health of the company as a whole.


Work availability


The cost of labor is such an important concept for the business of professional services that it deserves a special mention.

Let's remember what it is. From the company owner's point of view, at the highest level, the process looks like this: the company buys time from employees (this is called "paying salaries") and then sells that time to customers. That is, the company makes a profit from selling customers time, knowledge and competencies of employees. Time has a "purchase" price – this is the cost price. If we bring this price to some unit of measurement, for example, to one working hour, then for each employee we will get a cost rate, that is, we will know how much each hour of the employee's work costs for the company.

Calculation of the rate


In the case of hourly wages, the calculation is obvious - the cost price is equal to the employee's hourly rate, taking into account taxes and deductions directly related to it.

To calculate the cost of an hour of employees with a fixed salary, it is necessary:

  • Get the full amount of direct costs per employee for the past period (more often for the past fiscal year or for 1 month).
  • If possible, take into account future changes, such as salary increases.
  • Get the expected amount of working hours for the period.
  • Divide the cost by the expected number of hours for the planning period.
  • What period should be used for calculation? The monthly period allows you to update the cost more often, which is important in the case of frequent salary changes, but the costs from month to month can fluctuate greatly, for example, due to the presence of annual bonuses. In addition, frequent updating requires a lot of effort.


How to estimate the planned volume of hours? In a rough version, these are hours according to the production calendar (for full-time employees). More precisely - according to the individual schedules of the employee.


Accounting vs Management Rate


The rate calculated in the previous section is the model rate used in management accounting. Also, the "accounting" rate is applied, calculated on the basis of actual data for the already past period, so it will not be possible to use it for planning in any case.

Why do you need a managerial cost of an hour:

For planning.


To estimate the actual cost according to the management methodology, and this is important for the project team.


The team, when planning a project, proceeds from the existing cost of resources (they may change if the project is long," but such changes are smoothed out). Accordingly, the assessment of the success of the work and the motivation of the team should be based on the results of the project (primarily profitability), calculated at the same rates. Otherwise, the team has uncertainty and no influence on the final result.

On the other hand, it is important for the company's management to see a picture as close as possible to reality and therefore an assessment of profitability at cost of accounting is required. If there is a deviation from the plan, then the problem may be in the project itself or in the incorrect assessment of the management cost of the hour, which would lead to incorrect planning, and this is the problem of the financial director or other person performing such calculations.

Practical advice


To plan and evaluate the effectiveness of the project team, use the management cost rate. The profitability of the project cannot depend on when this project started.
Determine what accuracy of calculating rates for management accounting is sufficient. The most accurate approach is to count separately for each employee. The simplest is to calculate the average rate for all employees.
Do not include indirect costs in the rate. This will hide the real source of the profitability problems.
Project Budget
To build financial statements you need a plan, it is also a budget. The budget consists of revenue and expenses.

Project budget in management accounting


Planning revenue and direct costs is usually not difficult. As a rule, it is known in advance when the client will pay approximately, when a business trip will approximately take place or a contractor will be involved. But what about the cost price?

How to plan the cost price


If the management cost rates for each employee are known, then the process is quite simple. Recommended algorithm:

We define the stages of the project.
Define the list of performers for each stage
For each performer and stage, we estimate the amount of hours that the performer will need. It is important that here we are not talking about the term, but about labor costs.
The evaluation of the clock can also be broken down by time periods, for example, by month.
If the company keeps records of working time for projects, then at this stage you can rely on historical data. For example, see how many hours were spent on similar tasks and milestones in already completed projects.

When the planned hours and rates of employees are known, the calculation of the planned cost price is calculated by simple multiplication.

Budget execution monitoring


The second part of the financial statements is the fact of how much they actually spent and earned on the project, in other words, control over the execution of the budget.

Financial accounting policies


Before accounting for the actual execution of the budget, it is necessary to understand the type of accounting.

Two methods are used: the cash method and the accrual method. For example, upon completion of work, according to the accrual method, revenue recognition occurs when signing the act, and according to the cash method at the time of crediting money to the current account.

Accrual Accounting is a method of accounting and recognition of income and expenses, according to which the results of business transactions are recognized upon their occurrence, regardless of the actual time of receipt and payment of cash related to them.


Cash Accounting is an accounting method in which income is recognized on the day of receipt of funds to bank accounts and (or) to the cash desk of the organization, or receipt of other property (works, services). Expenses are considered costs upon their payment.


The cash method is easier to understand, but in practice it is not very applicable for a number of reasons.

Different methods of financial accounting are used not only to track the fact, but also in planning, preparing a budget. In order for the budget to be compared with the fact, all operations must be planned and accounted for in one way.

Cost recognition


To solve the problem of cost recognition, it is impossible to do without the introduction of accounting for working time for projects.

Obviously, the actual cost price is calculated based on the actual contribution of the employee to a particular project. At the same time, employees during the week can work not on one, but on several projects, constantly switching between tasks. And to understand what proportion of the employee's costs per week belongs to which project - take into account the hours in the context of projects. In this context, the purpose of time tracking is to separate the cost of labor of employees between projects.

What the process usually looks like:

Employees use timesheets to record the hours actually spent on the project;
Managers check and coordinate timesheets of employees;
Based on the agreed timesheets, the actual cost price is calculated.


Project budget in management accounting


It is important that the cost price is charged. That is, the appearance of the actual expenditure operation under the article "Cost of labor" under the project is in no way connected with real payments. Salaries are paid twice a month, and the cost of projects can be calculated at least every day. In addition, the management cost rate is more often used to calculate the cost price. In a particular month, the amount of real payments to employees may differ from the cost price that was recognized for the projects.

In a good way, the transaction amounts and accrual amounts should roughly coincide on the horizon chosen for calculating management rates, but it is obvious that they will never coincide 100% and this is the price for the efficiency and visibility of the management report.

Revenue recognition


Revenue, as well as cost, must be recognized. The most common way is as the acts of work performed are signed. However, there are other ways.

If the project is paid for under the "Time & Materials" scheme, then revenue can be recognized as time sheets are agreed upon or for some period for all agreed time sheets.

Revenue recognition of fixed-cost projects by percentage of earned value is also applied:


At the beginning of the project, the total planned revenue for the project is known, as well as the cost of the project, the planned duration, the planned volume of hours.


At each moment, the percentage of project completion (development) is known to choose from: by duration (simply on the basis of elapsed time), by hours or by cost (based on agreed timesheets).
Accordingly, you can recognize the same percentage of revenue, for example, for the past month.
Such recognition is of a model nature and allows deviations from the real state of affairs. But recognition by percentage of completion allows you to control the economics of long-term projects with a given periodicity (for example, monthly), and this advantage is often critical.


Revenue recognition in management accounting


Practical advice


Organize the process of time tracking. Actual time expenditure is the basis for cost recognition and, for some approaches, revenue.


Prohibit employees from taking into account less time than they should work out on their schedule.
If employees with a fixed salary overwork , ration the cost.
Determine the revenue recognition method and recognition rules.


Income Statement


Having received the budget and information about its actual execution, the next step is to display the financial condition of a particular project, direction and business as a whole. The classic report is the profit and loss statement.

The structure of the report includes lines by accounting item and values that are optionally broken down by time period (for example, by month). The project report includes revenue and direct costs, allowing you to control gross profit and profitability, an example of the report:

P&L by Gross Revenue


A statement on a referral, division, or business as a whole may include indirect costs and thereby reflect operating profit and profitability:


P&L by operating revenue


Tips for automating management accounting


The level of automation must meet the needs and maturity of the organization. These are not empty words – there are often small companies that, out of a desire to do "as we believe right", try to use heavy enterprise-level solutions or develop their own solutions with numerous integrations. At the same time, the automation process often displaces the goal, and the economic feasibility of such automation is questionable.



The opposite situations are also not uncommon - mature companies feel the need for full-fledged management accounting, but do not dare to implement a separate specialized solution. A frequent case is that the company has a task tracker (task management system) and the management flatly refuses to implement time tracking through timesheets, because "there are already tasks." At the same time, the tasks do not provide reliable, consistent and complete data on working time, which breaks economic accounting.


Usually, companies go through three stages of automation of management accounting:

The entry level is the use of Excel/Sheets. And this is a reasonable approach for small companies, start-ups or for running processes in the first stage of automation.


The second level is the use of specialized systems for time tracking. The reasons are clear – time tracking through spreadsheets with business growth becomes a very time-consuming process. It is worth mentioning that for full accounting it is recommended to use timesheets in any form.


Further, companies are introducing full-fledged solutions for project budgeting and resource planning.
When implementing, it is important to understand the ultimate goal, competently convey the need for implementation to the team and not be afraid of mistakes, problems - they will definitely be, but everything is surmountable.



Counting Money on Projects – Practical Tips for Consulting


Whether your business is consulting, engineering, auditing, advertising or marketing, IT integration or other services, it is based on projects. In order not to go into the red, it is necessary to control the profitability of each project at any given time.



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