If you want your professional services business to be profitable, you must track utilization rates. Learn how to do it in our ultimate guide.
It is easy to suffer financial losses if you don't plan time carefully and utilize resources effectively. A good way to monitor how your business is doing is by looking at the utilization rate. But what is an organization's utilization rate, and how and when do you calculate it? What is a reasonable staff utilization rate? Are all rates computed the same way?
In this article, we'll look at how utilization rates are calculated, and why it's key to be able to calculate utilization rates accurately.
Utilization rate is the amount of an employee's work time that benefits the company. It is expressed in percentage form, with 100% equating to the ideal total capacity provided by your workers to earn you a profit. In reality, this 100% utilization rate is actually impossible to obtain. This is because there are many limiting factors you have to consider.
Each person's limiting factor includes holidays, work schedules, and planned leaves. It also includes the total hours spent on other company-related activities that don't yield any profit.
There are different types of utilization rates that are relevant to businesses, from law firms to creative agencies. These include:
This is a measure of how efficiently a machine or component is running. A calculation of a machine utilization rate enables:
For instance, if a machine has a low utilization rate, it means that the machine is idle most of the time. The high idle time could suggest that there are problems with the machine, or that it’s not being used enough by workers. Either way, it could be time to replace or repair the machinery. If machine utilization is not measured, this indicates poor planning and possibly interrupts the delivery of services and incurs costs that could be avoided.
An employee utilization ratio measures how long someone spends on billable work as opposed to non-billable activities such as training and attending meetings. A company must keep track of its employees' time and differentiate between the ways the time is used. Tracking billable and non-billable hours will give information about the effectiveness of your workforce.
Employee resource utilization can relate to billable or non-billable hours.
Billable hours are the hours spent by your team working on income-generating tasks. Most of these assignments are arranged with the client and included in the payment invoice. The implementation of the project, revision requests from clients, and other meetings and discourses are all considered part of the billable hours. Billable utilization is the ACTUAL time consumed to do the project.
Non-billable work, on the other hand, is not requested by the client but is still necessary to keep the business running. Non-billable work includes meeting with the team before a project begins, proposing a project to a new client, and training your team to upskill them. Even though these instances do not generate a direct profit, they still involve staff costs.
An optimal utilization ratio between billable and non-billable hours is often set at 80%. This is also sometimes referred to as the realization rate, representing the proportion of time that is billed to a client.
New to utilization? Check our guides here:
The first thing to do to calculate rates is to know what your business's current capacity is. This will be the standard against which you measure performance.
For example, if your production department produces 500 items per day, you can use that number as the benchmark for measuring their utilization rate. Then, if they produce only 450 items per day, they have a 10% lower utilization rate than they did before.
The same goes for your resources. The overall resource utilization rate shows you the percentage of your total resources used.
If you want to know how much of your personnel time is utilized, a utilization rate formula is simply a worker's total billable hours divided by their available hours.
So, if specialist A is available for 40 hours and works for 40 hours, you can measure how many of those hours are billable. For example, if expert A only has 30 billable hours during the 40-hour week, then specialist A's utilization rate is only 75%.
This is also referred to as the resource utilization rate.
A capacity utilization rate is the team's total utilization rate. Its formula involves adding together the utilization rates of each resource and dividing by the number of staff in the organization. This also gives you a clear picture of what your company's capacity looks like so that you can make future decisions from there.
If you want to see which resources are overused or barely touched, it is helpful to consider both capacity and resource rates.
But be careful to differentiate resource allocation from resource utilization. Resource allocation is used to select and manage the chosen resources, while resource utilization is the strategy on how to maximize the use of these resources. They are each are essential metrics to help the project attain its success.
The utilization rate for the organization's entire payroll to check if the work done for a specific payroll period is for billable time (direct labor) or non-billable time (indirect labor).
However, it is also important to look at the type of resource. For example, is the top legal practitioner in a law firm sitting idle the whole week? Highly-paid but inactive team members will significantly impact your staffing costs compared to your lower-paid staff enjoying coffee breaks and taking time off.
A business' target utilization rate is different with each company. There is no specific figure to work on because there's not a one-size-fits-all formula for an organization's needs.
A higher utilization rate may not always equate to higher profits either. A wide gap between realization rates and utilization rate may mean too much time is spent on non-billable tasks, or that too many people are working on a particular project.
According to Gartner's VP Analyst, Robert Handler, the average utilization rate should be below 80% to avoid work overload and decrease mistakes that may cause more problems for the business. This rate also accounts for the utilization ratio balance of both billable and non-billable work, avoiding employee burnout and reducing your team's idle time.
Our CEO Tim Copeland agrees. He shared this story with us:
A few months back, I engaged in a conversation with the CFO of a considerably large company. During our discussion, he recounted an experience where the company had shifted its focus from staff utilization. This change came after two decades of operating as a well-established organization. For about 20 years, utilization was their North Star, getting the most out of their staff's time. It was all about making sure everyone's busy and that supposedly drove their success.
However, they’ve come to realize that the skill set possessed by their workforce wasn't necessarily the most sought-after in the market. Consequently, they chose to temporarily step back from focusing on utilization and redirect their efforts towards comprehensive staff training and development, with a particular focus on their sales team. The company even sought projects aligned with the evolving skill set they were cultivating.
This strategic shift wasn't without its challenges. It involved a six-month period of significant adjustments, entailing substantial costs for the transformative process. The result, upon reevaluation, was a scenario in which their staff's utilization was lower than before, yet the work they were undertaking held greater value for their clients.
This transition yielded an intriguing synergy: the company's profitability increased while the workforce experienced reduced stress levels.
Operating under the premise that allocating 100% of staff time solely to work tasks left little room for creativity, and even practical considerations like sick leave, they recalibrated their approach. By targeting, for instance, 80% of planned work, they allowed space for spontaneity and creativity to flourish. Instead of aiming for that elusive 100% utilization, they dialed it down to 80%.
Ultimately, this balance facilitated a more productive and innovative work environment. Entrusting employees to manage their time effectively eliminated the need for micromanagement on an hourly basis.
To calculate utilization rate targets for your company, you need to sum up your company's resource costs, overhead, and profit margin. Then divide it by the total available hours multiplied by a target billable hourly rate.
Let's say your total resource costing is $100,000, the overheads cost $10,000 per employee, and your team has 2,500 hours available. If the goal is a 25% profit margin ($110,000 x .25 = $27,500) and your target billable hourly rate is $80, then:
(100,000 + 10,000 + 27,500) / 2,500 x 80 =
137,500/200,000 = 0.6875 or 68.75%
With the given data above, your organization's ideal utilization rate should be 68.75% to meet the 25% profit margin while charging $80/hour.
A higher utilization rate shows that members of staff are spending more time working on billable projects that can generate revenue for your company. It's important to track this metric because a high utilization rate involving more billable hours will help you make better financial decisions and avoid cash-flow problems.
Monitoring when and where X amount of resources has been used is an efficient way to ensure you are not overusing or underusing resources while keeping within budget. For example, are more resources used in non-billable tasks? Is the billable hours' record updated? Track utilization rates for individuals and gauge your resources' financial spending.
If you know that what you pay your team is eating into your business's profit, then spending on your non-billable working hours needs adjustment.
Is your current billing rate by the hour commensurate to your services? If you have a high utilization rate but low profit, you may check on deliverables quantity, productivity, direct costs, and overhead costs.
Is the billable work equivalent to the number in your workforce? If your utilization rate is low, you may not have enough work to offer your team. If it's close to 100, your resources may already be overused. If your utilization rate is above 100%, it may be because of a lack of good project planning. In this case, you may want to consider hiring new people to reduce your team's workload and improve productivity.
If your team is already logging in their billable hours and you are having a hard time plotting them, you may not be able to come up with an accurate utilization rate. Instead, get user-friendly software to track time and monitor billable and non-billable hours easily.
Good software can also help you understand patterns with your team's schedule, get a real-time update of available hours, and calculate total available hours as a team. If automated, time tracking also allows you to set cut-offs, increase a worker's or team's logged hours, and save you from all the manual-time logging hassle which could be devoted to more critical working engagements.
With Runn's Timesheets, accuracy in resource utilization is a breeze. You can categorize big chunks of work, organize your team's workload into billable and non-billable hours, and know when and where your highest billable costs are.
Knowing your team's utilization rates does not help you assess the company's overall available time. Instead, use Runn's Group utilization charts to step back and look at the bigger picture. Monitor your capacity utilization rate as a team or group of teams. This software provides accurate information visually to make quick, clear-cut solutions and high-level industry decisions. Once you have sorted out the people filters: tags, group, team, and role, you won't be missing out on the details of your utilization chart.
Now that you have the means to track billable time for both team and team members, it's also important to sit down and analyze the metrics. It's not enough to be left with percentages without knowing how to scrutinize and interpret them.
Runn's People utilization reports allow you to backtrack and forecast your workers' utilization rates. These rates will allow you to compare the actual with the approximate costs, improving gaps and not judging employee performances.
It also helps you create sound predictions and implement actions based on when your team will have more free time, which roles are needed or optional, which people are overutilized, and when you will be ready to upskill or train, hire new staff, or accept new clients.
When you calculate your employees' utilization rates it's not only for your knowledge of their available and billable time. It's also a tool to assess your company's development in terms of profitability, capacity, and ability to expand to a higher level.
Ready to optimize the utilization ratio of your team? We'll help you maximize your resources and offer the latest planning, tracking, and forecasting resource management strategies. Book a demo with us today!
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