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In the quest to understand performance and boost profitability, most businesses continually measure a ton of different metrics, ranging from customer satisfaction and employee engagement, to lead generation, marketing conversions and sales indicators. But perhaps the most universal metric for any business is utilization rate.
If you don’t understand your utilization rate, you can’t understand your efficiency and productivity – which means you can’t begin to evaluate the profitability of your business. That’s why a multitude of businesses, from creative agencies and professional services through to law firms and independent consultants, closely monitor their utilization rate. But how exactly do you calculate it accurately?
What is utilization rate?
Simply put, utilization rate is the percentage of a person’s total working hours that are spent on work that can be billed to a client. No matter how motivated or productive an employee is, no matter how determined they are to do the absolute maximum, time will always be their limiting factor. There are only 24 hours in the day – and as we’ve explored in depth before, human beings don’t do well when we strive towards being “always on”.
While an employee may work 40 hours a week, it’s pretty much impossible to do 40 hours of billable work. Meetings, lunch breaks, phone calls, training and business development all eat into it. But when it comes to utilization rate, it’s important to get the balance right: if it’s too high, your business may be cutting corners with essential internal work and you probably need more resources; if it’s too low, you may not bringing in enough work for your head count.
Why should you monitor utilization rate?
There are several reasons why it’s so important to monitor utilization rate. Any company that bills by the hour – whether that’s an agency or a law firm – needs to know whether they’re billing enough to cover their costs plus overhead. If you have a healthy utilization rate, you’ll know you’re billing efficiently. Plus, once you’ve figured out your ideal utilization rate, you can then use it to help understand many other important business functions.
Utilization rates are especially important when it comes to resource management, and can significantly improve forecasting and resource optimization. As a company grows and teams expand, the importance of having visibility into your future becomes even more vital – and your utilization rate can let you know whether you have the capacity to take on a new client, whether you need to hire more people, if you’re spending enough time on client work and whether you should invest more in internal projects.
How do you calculate utilization rate?
So what’s the best way to calculate utilization rate? The basic formula is pretty simple: it’s the number of billable hours divided by the total number of available hours (x 100).
So, if an employee billed for 32 hours from a 40-hour week, they would have a utilization rate of 80%. There are actually several different ways you can calculate utilization rates depending on whether you want to understand pricing, hiring, organization health, etc.
To work out your utilization rate on a firm level, just divide the total of all employee utilization rates by the total number of employees. Most robust time tracking solutions can provide this information for you at both an employee- and business-level.
What is a good utilization rate?
So what does a good utilization rate look like? Ultimately, this depends on the company; there isn’t a specific number that works for everyone, and certainly it isn’t a case of the higher the utilization rate, the better. A utilization rate that’s continually close to 100% suggests that staff are overworked and potentially close to burnout. If this is the case for you, it’s an indication that it might be time to hire new people. If you have a utilization rate above 100%, that’s usually indicative of too much out-of-scope work or poor planning.
But on the flipside, if there’s a big gap between utilization and realization rates, it either means your team is spending too much time on non-billable tasks, or there isn’t enough work in the pipeline – which suggests there are risks ahead. It could also suggest that you have too many freelancers involved in projects. The bottom line, however, is that it means you need to bring in more billable work. To give you more insight, you can use the ideal utilization rate formula, which is:
(Costs + Profit) / Potential capacity x Billable rate) x 100
By dividing the resource costs, overhead and profit margin by the total available hours and billable rate, you can calculate the ideal utilization rate – which is the optimal utilization rate for a company to reach the desired profit margin.
Before you can begin to work any type of utilization rates, however, you need to be able to gather accurate information on where your time is actually going and how much of your work is billable. Understanding your utilization rate is vital if you want to successfully judge the profitability of your employees, team and company – and while it’s a simple measurement, it can have far-reaching effects on how your business runs.