Project Profitability: Revenue, Cost, Margin and Cash Explained

The four numbers

Ask four people in a service business whether a project was profitable and you can get four different answers, all correct, because they are answering different questions.

• Revenue. What the client agreed to pay for this work.
• Cost. What delivering it cost you, which for client work is mostly people.
• Margin. Revenue minus cost. Whether the work was worth doing.
• Cash position. Money in minus money out. Whether you can pay anyone this month.

The first three describe whether the business model works. The fourth describes whether the business survives. They are related and they are not the same, and a business that tracks only one of them is guessing about the other.

Revenue is not what you invoiced

Three different figures get used as revenue on a project, and they are rarely equal:

• Agreed value. What the client committed to. This is the right denominator for profitability.
• Invoiced. What you have actually billed so far. On a staged engagement this trails the agreed value for months.
• Received. What has arrived. This trails invoiced, sometimes considerably.

For margin, use agreed value. You are asking whether the work is worth doing at the price you set, and that question does not depend on how far through the billing cycle you happen to be.

One complication worth handling deliberately: agreed value changes. Scope gets renegotiated, a phase is added, a discount is agreed. When it does, record the new figure and keep the old one. A project whose agreed value quietly rose from 10,000 to 14,000 looks like it improved; one where you can see both figures tells you it was renegotiated, which is a completely different fact.

Cost is not what you paid

The mirror-image mistake. What you have paid out so far is a cash fact, not a cost fact, and on any project longer than a payment cycle the two are far apart.

Three states, and the distinction matters more than it sounds:

• Pending. Work done or underway, not yet approved. You will probably owe it. You do not owe it yet.
• Approved. Work accepted. You owe this now, paid or not.
• Paid. Money gone.

For margin, use approved cost. It is the closest thing to a true cost of work delivered, and unlike pending it is not going to change.

But keep pending visible next to it, because it is the early warning. Approved cost tells you where you are. Pending tells you where you are about to be.

Two margins, not one

Given the above, one margin figure is not enough. Two are, and they should sit side by side:

Confirmed margin = agreed value minus approved cost. What the engagement has made on cost that is settled. Every figure in it has been through review.

Exposure margin = agreed value minus approved cost minus pending cost. The same engagement once work already in flight is counted.

The gap between them is the amount of margin that is currently at risk from work that has already happened. On a healthy engagement it is small. On one heading for trouble it is the first thing to move, weeks before anything else does.

Margin is not cash position

This is the distinction that surprises people who are otherwise good at this.

Cash position = client cash received minus team cash paid out.

Both terms are money that has actually moved. Not invoiced, not owed, not accrued. It answers one question: is there money.

A project can be excellent on margin and alarming on cash, and this is the normal case rather than an exception. You paid your team last month; the client pays on 45-day terms; the project is profitable and you are funding it. Equally a project can be flush with cash and unprofitable, if a large deposit arrived early on work that is going to cost more than it earns.

Report both. Neither substitutes for the other, and averaging them produces a number that describes nothing.

A worked example

One engagement, part way through. Agreed value 20,000.

• Approved cost so far: 11,000
• Pending cost, work done but not reviewed: 3,000
• Paid out to the team so far: 8,000
• Invoiced to the client: 12,000
• Received from the client: 7,000

From those five figures:

• Confirmed margin = 20,000 minus 11,000 = 9,000
• Exposure margin = 20,000 minus 11,000 minus 3,000 = 6,000
• Cash position = 7,000 received minus 8,000 paid = minus 1,000
• Outstanding from the client = 20,000 minus 7,000 = 13,000
• Owed to the team = 11,000 approved minus 8,000 paid = 3,000

This engagement is profitable, is a third less profitable than the headline suggests, is currently costing you money to run, and has 13,000 still to collect. All five statements are true at once, and no single number expresses them.

Margin percentage, carefully

Percentages are useful for comparing engagements of different sizes and dangerous for two reasons.

First, decide the denominator and stick to it. Margin as a percentage of agreed value is the usual choice and the more conservative one. Margin as a percentage of cost produces a larger, flattering number that is not comparable to anybody else's.

Second, be careful with percentages on engagements in different currencies. If revenue is in one currency and team cost in another, the percentage is only meaningful once both have been converted at a rate you have actually recorded. Subtracting one currency from another produces arithmetic that looks fine and is meaningless, and it usually shows up as a margin figure that is wildly negative or several hundred per cent.

Which number, when

• Deciding whether to take the work: expected margin against agreed value, using rates you have actually recorded.
• Watching an engagement in flight: exposure margin. It moves first.
• Reviewing a finished engagement: confirmed margin, plus how much of the cost was unplanned.
• Deciding whether you can pay people this month: cash position. Margin cannot answer this and should not be asked to.
• Repricing for next year: confirmed margin across many engagements, with the additional work broken out separately.

If you track only one, track exposure margin during delivery. It is the only one of the four that gives you time to change the outcome.