This article is the 2nd among the series of 4 articles aimed at helping IT services companies increase their profitability.
For an IT services company, or for any business, the bigger picture is always the financial performance. No matter how much efforts are put in serving the clients, it is worth the effort only if the financial outcome is optimum. Better financial performance translates into multiple advantages - from more resilience to increased valuation.
Every CEO or founder of an IT services company worth his salt will know finances in and out. But these parameters are often neglected in the grunt of day-to-day battles. The intention behind re-iterating these common sense points is to again draw your attention to them and to urge you to always have an eye on them no matter what.
This is the second article on our series of four articles. In my last article, I spoke about why attaining the maximum profit potential is critical for IT services companies in today’s times. In this article, I will talk about how IT services companies can optimize their financial performance.
How much profit is ‘enough’?
The ultimate indicator of any company’s financial performance is its profitability. The profitability is measured in terms of PAT - the profit after tax. We can get a fair idea of financial performance of any company if we know the PAT figure. Most of the IT services companies are generally net positive. Some companies register a PAT of 7-8% and are happy with it while there are some companies that have PAT as high as 20% and still trying to improve it. The question is - how do we define what is optimum PAT for an IT services company?
Answering this question is tricky because every company differs from the others on parameters like services they offer, scale on which they operate, clientele etc. As companies grow bigger, maintaining profitability becomes difficult as the complexity of the business increases.
Whenever a founder or a CEO of an IT services company asks this question to me, I give them the example of TCS. TCS is probably as big and complex as things can be and still, they make 20% PAT consistently, every year. While there is no defined optimum PAT number, one can always look at the best and aspire to attain that.
How can IT services companies optimize their financial performance?
As we discussed earlier, we can take PAT as the indicator of financial performance. PAT is calculated as :
PAT = Revenue – Operating Expenses – SG&A – Finance Cost - Taxes
The most direct way of increasing profitability is increasing revenue and minimizing the operating expenses. By increasing its revenue and bringing down the operating expenses, it is possible for the IT services companies to improve their financial performance.
How can IT services companies improve their revenues?
a. Better sales process and conversion : A company can increase its revenue substantially by optimizing its sales and conversion process. The sales process comprises of a large number of steps and at each step, leads drop out. Optimizing the entire sales process and minimizing losses at each step is crucial to increase the revenue.
b. Excellent delivery : If a company has a highly efficient delivery team, it will be able to handle more projects and thus generate more revenue. Often, delivery teams operate at low efficiencies and as a result, the organization is not able to reach its full revenue potential.
c. Minimize revenue losses : Imagine you have a project at hand but no team or bandwidth to deliver it. In such cases, the company will have to pass that project which leads to lost revenue. If the hiring team has clear visibility into the near future requirement and are able to hire in time, revenue losses can be minimized. Attrition also contributes to revenue losses and can be tackled with better pay, work culture, and growth opportunities.
d. Revenue leakages : Factors like leaves and unfilled or non-billable timesheets lead to revenue leakages. Revenue leakages might look small in size but add up to make a big impact on the financial performance of the organization. Revenue leakages happen at multiple sources and in small quantities and hence, putting a check on them becomes difficult.
How IT services companies can bring down their operating expenses?
a. Optimizing project pyramids : Optimized project pyramids mean you have correct team structure for your projects. Unbalanced project pyramids lead to higher expenses than required. A look at project pyramid can tell you where you are overspending and by optimizing the pyramid, you can immediately bring down that expense.
b. Attrition and cost of replacement : Attrition significantly increases the expenses of any IT services company. Finding, on-boarding and training new recruits and bringing them to a stage where they perform as expected have costs associated with them. Often, attrition leads to hiring people at above the market price and increases the expenses substantially.
c. Bench optimization : It is impossible to completely eliminate the bench but companies can certainly optimize their bench to minimize its impact on the financial performance. By looking at bench pyramid, companies can improve resource utilization, avoid hiring in excess or identify upscaling opportunities for better resource utilization. Visibility into the sales pipeline is important for bench optimization.
d. In-house growth vs. lateral hires : Lateral hiring increases expenses significantly. Training and grooming talent in-house is cost effective and gives better results.
Increasing revenues and minimizing operational costs are two essential steps to optimize the financial performance of any IT services company. There are a number of best practices that companies will need to follow to accomplish these two tasks. At Instazen, we have developed a business operating platform which helps IT companies improve their profitability by helping them address these issues. Please get in touch with me at email@example.com to know more about improving the financial performance of your organization