When a business has numerous projects, keeping track of their outcomes can be challenging. Revenues and expenses merge into a single financial result, and the owner may struggle to determine which projects are profitable and which are dragging the business down. So, how can we assess the effectiveness of each project and what should we do with unprofitable ones?
Why Monitoring Project Profitability is Important
A project is any activity aimed at achieving a specific goal. For example, opening a branch, launching a new website allowing players to bet on sports, introducing a new service, developing a marketing strategy, or arranging a new workshop.
If a company doesn’t keep proper records, it becomes difficult to track the closure of each project. Without understanding the results, it’s impossible to determine whether a project is profitable or not. Some projects might be “eating away” at the business’s profit and leading to serious financial difficulties. To prevent this, it’s crucial to identify unprofitable projects in a timely manner. Calculating their profitability can help in this process — it shows how effectively the invested funds are being used and is calculated as the ratio of profit earned to resources spent.
Profitability assessment also helps determine:
- The impact of investments: The business owner can see how much money will be earned and when the investment will pay off.
- How to allocate the budget among different projects: For instance, if one project is highly profitable, it might make sense to increase its funding to improve the overall performance of the company.
- Whether to continue supporting a project: If it’s unprofitable, it should either be closed or its strategy should be revised.
Standard management and accounting reports show the overall financial results of the company, but they don’t provide information on which projects yield the most benefits. So, it’s important to look not only at the overall outcome of the projects but also to keep records for each one individually.
How to Track Projects
Project accounting is a part of management accounting that helps see the financial result and profitability of each project separately. The main principle is to gather revenues and expenses and distribute income and payments by project.
To start project accounting, follow these steps:
Step 1: Identify Projects Based on Business Specifics
The following options are possible:
- Business Areas: For example, a company may have wholesale and retail trade: warehouses and several stores. Since each area has its own specifics, they can be separated into different projects.
- Sites: These could be a production workshop, a store, or a café within the same company.
- Objects: This approach is convenient for dividing projects related to construction or renovation.
- Clients: This option is suitable for companies that provide various services, such as consulting, auditing, or financial accounting.
Large companies may have multi-level projects and those dependent on the implementation of others. They are divided by areas and stages. This approach helps understand where each project stands and make the right decisions regarding its further development.
Step 2: Separate Revenues and Expenses by Project
It’s not difficult to link revenue to a specific location, client, or area. This can be tracked through incoming payments and automatically distributed across the necessary projects in financial accounting services. Expenses are harder to distribute since not all of them can be attributed to a specific area.
Expenses are classified as direct and indirect. Direct expenses are those that can be directly attributed to the cost of specific goods or services. Indirect expenses are those that cannot be directly included in the cost of a specific product.
For example, a company has a store and a café located in different rented spaces. Rent, utilities, and the salaries of the store’s sellers, cooks, and waiters can be directly attributed to each area. These expenses are considered direct. However, the company also has other expenses: the salary of the director, accountant, and costs for office maintenance and rent. These cannot be directly attributed to the store or restaurant. Such expenses aren’t included in the cost but are distributed among projects according to a chosen methodology, such as proportionally to revenue or labor costs.
Step 3: Choose an Accounting Service
Simple projects can be tracked in Excel or Google Sheets. These are convenient tools that can be customized for any request. However, they have a significant drawback — data must be entered manually.
If a company has large turnovers and several large projects running simultaneously, it’s worth considering automating the accounting process. This can help minimize errors, save time on data processing, and allow the owner to receive the necessary information more quickly to make informed management decisions.
How to Forecast and Evaluate Project Profitability
The profitability indicator represents the ratio of profit earned to resources invested, meaning it helps understand how successfully the company or a specific project is operating. In practice, project profitability is calculated at the planning stage, during implementation, and at the completion stage to summarize the results. During planning, this indicator is calculated based on estimated costs and expected profits. It’s unnecessary to calculate it exactly — an approximate estimate of project profitability is enough to decide which one to pursue and which to abandon.
The initial profitability calculation helps determine whether it’s worth investing resources into the project.
Profitability is expressed as a percentage, making it easier to evaluate and compare with results from different periods or the industry average.
Ongoing projects are assessed based on the gross profit and its profitability. This helps understand how much the company has earned.
Gross profit is the difference between sales revenue and cost of goods sold. It shows how much money the company will have left after deducting direct variable and fixed production costs from the revenue.
By calculating the gross profit for each project, we can immediately see which projects are generating profit and which are incurring losses.
Gross profit margin helps assess the efficiency of each project as a percentage. The higher this indicator, the better. This way, the owner understands which project to continue funding and which requires a review of expenses, development of a new marketing strategy, or closure.
What to Do With Unprofitable Projects
Based on the calculated indicators, the owner must decide what to do with unprofitable projects: try to fix the situation or close them. It’s important to understand that closing a project is the simplest but not always the most optimal solution.
If the business owner chooses to keep the project, it’s necessary to improve its financial performance. This can be done by finding new suppliers, enhancing employee skills, improving product or service quality, reducing costs, changing marketing strategies, or revising pricing policies.
When a project is not only unprofitable but also occupies a small share of turnover (no more than 5%), it should be closed, and resources should be redirected to other projects that generate income.
