Accounting + Utilization Rate For Your Small Business

If you are a service based small business, you more than likely can measure the utilization rate of your employees.  At a basic level, utilization rate measures what percentage of your employees time is spent on work that is billable to a project or client.  Your accounting of finance department should be able to track this for a small business owner.  For instance, if you work in a law firm and you have an employee with a 65% utilization rate, that means they spent 65% of their time billing their time to a client. 

For a service based business, measuring this rate can be imperative to their success.  By measuring this rate, an entrepreneur is able to assess many factors that are critical to their success and profitability. For instance, they can determine how to set their prices for their clients, how much their bookkeeper should invoice their customers, decide how much to manage their payroll, and how effectively their employees are spending their time.

How to Calculate Utilization Rate

The calculation of utilization is fairly simple for a small business.  The first step is to have some sort of time tracking system in place.  Without this, the calculation becomes much harder, if not impossible for an entrepreneur.  By tracking their hours, your accounting team can get the two basic items you need to calculate the utilization rate for an employee: total hours and total billable hours.  The result is expressed as a percentage. The formula is very simple:

Total Billable Hours / Total Hours = Utilization Rate

What is the appropriate utilization rate?

Here is where the concept of utilization gets interesting and murky.  An appropriate utilization rate for an employee is often determined by the business model, the type of employee, and how the small business is categorizing employee hours.

I spent over 10 years in a large regional public accounting firm, so I can speak pretty intelligently to utilization rates for this industry.  As an audit staff, I was expected to be between 70-75% utilized.  All of my hours, even vacation hours, went into the base of my calculation (total hours).  That meant that my total hours not only included billable hours, but it also included training time, vacation time, and general and administrative tasks.  A basic year includes 2,080 hours (40 hours x 52 weeks).  However, we were expected to have total hours of 2,450.  This included 4 weeks of vacation and 40 hours of training.  Therefore, in a given year I was expected to work on client work for at least over 1,700 years.

As an accounting staff, I didn’t have a ton of control over my billable hours.  There was no expectation to bring in work, so I couldn’t necessarily affect my billable hours by that.  The best I could do was try to find work when I wasn’t busy.  However, my bosses were interested in my utilization rate for another reason.  I was not the only audit staff, there were about 40 of us.  If our group utilization rate was less than 70%, it might have signaled we were overstaffed.  Likewise, it if was too high, it might have signaled we were understaffed. 

Our utilization rates were published every week for all to see.  While this was very at times, I could see why it could be stressful for people, it was also a tool that managers and partners could use to evaluate employees.  It is also important to notes that the expected utilization rate was different for each level and sometimes even for roles.  A small business owner should be careful in applying a blanket utilization rate for all of its employees.

Improve Utilization, Improve Revenue

There is another important concept will talk about in a later article referred to as realization, which is the number of billable hours actually billed to clients (if a billable hour is not billed to a client, it is “written off”).  With that said, as the utilization rate increases, service businesses will generally see an increase in revenue.  This is because as the utilization rate increases, more client work is being done.  It could also mean that you have fewer employees, which increases profit. 

Is Utilization Appropriate for My Business?

While professional service firms are notorious for tracking and closely monitoring utilization rates, most service-based small businesses can track a utilization rate of some sorts. 

For instance, if you have a roofing company, you can track total hours worked by employees installing a roof versus total hours.  You might find that your employees are spending a huge amount of time traveling or getting supplies.  This might cause you to alter your business so that you are better estimating supplies at the outset of a job or scheduling people closer to their homes.  You might even decide to not work in a certain part of town because your spending too much time traveling.

Using your accountant or small business financial advisor, you can determine a method to implement tracking time and what you want to track.  While this is just the tip of the needle on this topic, when you take a deep dive into utilization it can become a major management tool that an owner uses to manage their small business.