For buyers and sellers preparing for a transaction, few metrics reveal as much about the health of a professional services business as utilization and realization. Below are the four areas we focus on in every professional services quality of earnings (QoE) engagement.
Utilization and Realization: The Two Numbers Behind Every Deal
To assess the health of a professional services business, both utilization and realization need to be measurable and clearly interpreted. As such, it is important that professional services businesses track daily time and expense by person by project.
Team utilization measures the percentage of an employee’s or a group’s available working hours spent on billable tasks. A range of 70% to 85% is generally considered a healthy, sustainable target for professional services teams.
Billable realization is the percentage of billable hours a team successfully invoices to clients and collects as revenue. The trend in realized billable rate per hour (or per unit) is the metric that matters most, not the snapshot. For example, a team can show high utilization while realization quietly erodes as scope creep, discounting, or unbilled overages accumulate.
Fixed-Fee Project Profitability and Overrun Risk
Fixed-fee arrangements deserve extra scrutiny because the customer’s payment doesn’t adjust even if the cost to deliver does. It’s especially important to measure realization on historical and current fixed-fee projects to understand profitability on a project-by-project basis and to assess the risk of post-closing cost overruns that can’t be billed back to the customer. A 12-month fixed-fee project that is 80% complete but only 60% billed, for instance, is carrying overrun risk that won’t show up in the financials until well after closing. The longer a project runs, the more room there is for that risk to build undetected.
WIP Aging, Write-Offs, and Accrued Revenue Risk
Work in Process (WIP) is hours or units consumed multiplied by bill rate, in effect, revenue the company has earned but not yet invoiced. When evaluating a professional services company, it’s critical to monitor how WIP ages and how consistently it converts into actual invoices. WIP that is growing older, or growing as a percentage of revenue, without converting to billings is a signal that work is being performed faster than it’s being billed, and often a precursor to a write-off. Because WIP typically sits on the balance sheet as an asset, an unexpected post-closing write-off effectively reverses revenue the buyer already priced in.
Invoice Aging and Collectability
As with any company, accounts receivable aging and write-off history deserve close attention. But professional services businesses carry an added wrinkle: if invoices don’t match the underlying customer contract, or go out without the customer’s consent, collectability risk rises sharply, and post-closing AR write-offs become far more likely. Reviewing invoices against signed contract terms, not just against the AR ledger, is what catches this before it becomes the buyer’s problem.
How ML&R Can Help
ML&R has deep experience evaluating software and technology-enabled services companies in transactions, and because most software companies carry a meaningful professional services component, we assess the two together as a matter of course. Whether you’re preparing a services business for sale or evaluating one as a buyer, understanding these four areas before you’re at the negotiating table is what turns quality of earnings from a compliance exercise into a real source of deal leverage.
If you’re preparing for a transaction involving a software or professional services business, contact ML&R’s Transaction Advisory Services team for a conversation about what a quality of earnings analysis could uncover before you sign.
