On Timesheets and Cost Allocation

Earlier this week I received an email from friend of VeraSage, Kirk Bowman of Mighty Data, who, by the way, his given himself the great title of Visionary of Value in his email signature and on his business card. He writes:

At the most recent meeting of our FileMaker Business Group this week, I got a question for which I did not have a good answer. The question is, if we are not tracking time, how do I know if a specific project is profitable? They were asking for a metric to measure financial success or failure on a project by project basis. I’m going to review the slides from August but I thought I would ask your input also.

The short answer is, “If overall profit is up xx percent, who cares?”

The more detailed answer: You allocate your costs ahead of time, like Toyota does as they do not have a traditional cost accounting system. They use what is called targeted costing.

Say you plan to do 12 major projects a year and $1.2 million in overall cost. You would start by allocating $100,000 to each. Now some would argue that some projects are bigger than others. OK, fine. Let’s allocate $200,000 to two of them, $50,000 to four of them, and leave the remaining six at $100,000. Of course, you can adjust them based on your judgment, so long as the total remains $1.2 million.

Project Straight Adjusted
A 100,000 200,000
B 100,000 200,000
C 100,000 100,000
D 100,000 100,000
E 100,000 100,000
F 100,000 100,000
G 100,000 100,000
H 100,000 100,000
I 100,000 50,000
J 100,000 50,000
K 100,000 50,000
L 100,000 50,000
Total 1,200,000 1,200,000

Is it perfect? No, but allocating costs based on a time unit is just as flawed as assigning value to the customer based on a time unit. It is the same false premise: value or cost does not equal rate times hours.

Is an hour billed on a project a good thing or a bad thing? No one knows, some hours might be good others bad. It is a judgment and therefore there is no reason to measure it. Allocating costs as above will make you approximately correct, rather than precisely wrong!

Tracking time might make you a better cost accountant, but cost accountants make lousy pricers. I would rather be a better pricer.

Lastly, timesheets are the cancer of the professions. They cause us to focus on the wrong things, the inputs. Professionals should focus on the right things, the outputs to the customer: deliverables, objectives, overcoming risks, solving issues, etc.

TIMESHEETS DELENDA EST!

5 thoughts on “On Timesheets and Cost Allocation

  1. I used to fret and worry about measuring project profitability as well before we kicked our timesheet habit at Azamba. The funny thing is… like most small consulting practices, we NEVER measured profitability per project before and I was letting it hang me up on moving forward.

    The reality is that we have more project accountability now than at any time in the past. We conduct after action reviews of most projects over a set size and we ask ourselves:

    1. Did we deliver what we promised?
    2. Did we deliver it on time?
    3. Is the client happy?
    4. Are we happy?
    5. What did we do well?
    6. What did we do poorly?

    There are other questions that get asked but that’s the crux of it.

    I don’t think it’s too surprising to anyone to state that we usually know what went wrong and who the guilty parties were before we get to this review stage. The formal process helps us lay it all on the table so we can improve as a group and learn to take better care of our fellow teammates and our clients.

    From a profitability perspective, I look at the monthly numbers coming in and going out and measure it that way – just like I always did. The difference is with the new model – the clients are a lot happier and we don’t spend time haggling about hours after the fact.

  2. Ed, you can also remind folks that traditional timesheets do NOT measure opportunity costs. A consultant costing the firm $50/hr can be costing the company far more by “wasting” his time on a little project for a customer who modifies a report once a year — instead of working on a project for a customer which is one in a sequence, each completion leading to more work and more referrals. Even though the billing rate for the time is the same.

    The timesheet shows the cost to the firm as the same. Clearly it is not.

  3. Just watched the video from your friend and mentor. I agree that when your service is intellectual capital, the value of the service versus the time it took to create and deliver the service is what the client should be charged. So how does one determine that value in advance of actually creating and delivering it?

  4. Jonathan, sorry for the much delayed reply.

    The short answer is that during discovery you and he customer codevelop the perceived value. In his seminal work, Let’s Get Real or Let’s Not Play, Mahan Khalsa provides a wonderful methodology for getting to this value.

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