Warring Performance Metrics: Utilization vs. Realization
For those of you entering or working in public accounting, it will be essential that you understand the key performance metrics your firm likely uses to evaluate you. Today we're going to examine utilization and realization, which are the two main performance metrics in public accounting and explain how they can be at odds with each other.
Utilization
Utilization is a performance metric that is meant to measure the effectiveness of staff relative to an overall hours budget. Firms use utilization as a performance metric to understand how productive any given staff member is relative to what the firm expects. At the end of the day, the firm is hiring staff to get jobs done, and utilization is a metric that allows the firm to evaluate how much time a staff might be spending on those jobs at a high level. If staff are not being utilized enough, then they aren't worth keeping around for very long since the firm is paying them salary and not getting enough chargeable hours in return. Utilization can usually be calculated as follows:
[Chargeable Hours Logged] / [Budgeted Chargeable Hours]
You may be thinking that this metric can be exploited because logging chargeable hours does not necessarily mean the work was done, and you would be right! This has an even bigger impact if you are working for a smaller firm where the engagements are a fixed price and therefore the firm isn't being paid by the hour for the time that staff members are putting in. This is precisely where utilization starts to fall short: staff want to maximize their utilization because it makes them look good, but that could mean doing work inefficiently to have more hours logged. In theory, if the work were performed efficiently, the staff could dedicate the extra time to performing another job and therefore making more money for the firm. This theory does not always apply depending on how big and busy your firm might be but understanding this theory is key to interpreting the information in a practical sense. This shortfall of utilization tends to be offset by examining realization on jobs alongside staff utilization.
Realization
Realization is a metric that compares the amount of time put into a job versus the amount of money collected from it. Realization is generally measured using either of the following equations:
[Chargeable Amounts Incurred] / [Amounts Collected]
-Or-
[Chargeable Amounts Incurred] / [Budgeted Amount]
Every firm has a set chargeable rate for each employee, and when employees put their time in the system, the firm will apply that cost to a given job. For example, if my chargeable rate is $200 per hour and I logged 8 hours to ABC Company, our internal accounting system would indicate that my time has generated $1,600 worth of time to be applied to the ABC Company budget (and hopefully their invoice). Unfortunately, there are many cases where billing for all this time is simply not possible. These cases create the difference between the amount that is billed internally to the system and the amounts that are billed to the client. These differences most often arise because:
The engagement is based on a fixed fee (and therefore cannot easily be billed beyond a limit), or
Billing for additional time could strain the client relationship (to the point where it is not worth it to bill the extra time this year)
If a job does not meet certain realization targets it might not be worth taking on because the firm is putting too many resources into something that does not yield an appropriate return.
While utilization is a generally a personal metric, realization is an engagement metric. For many firms it is not possible to accurately calculate an employee's realization because hours that are written off are not usually traced back to the person who billed them. Managers tend to be evaluated on how well their engagements go and realization is one of the key areas. Therefore, it's in an engagement manager's interest to have the least amount of chargeable hours (within reason) to show that they can get the engagement done more efficiently and come in under budget. At the same time, not charging all hours to an engagement can hide some of the key issues from the Partner, who likely needs to know about those issues when considering how to justify a fee increase for the client.
When comparing the practicality of these two metrics, we can see that there is a conflict. With utilization, staff want to charge as many hours as possible to make themselves look good and busy (which can sometimes lead to inefficient work). On the other hand, good realization on the job depends on spending fewer hours to get the work done. As a result, you could end up with the following:
Staff that want to bill as many hours as possible without regard to how efficient they are but are scared of a negative performance review if they blow the budget on any given job.
Managers who want the staff to Bill only the most efficient hours (and possibly eat hours to make this year look better), who also want to get the job done on time and accurately account for any abnormalities that could be billed as out of scope work.
As a staff there is usually no way to make everybody happy. The best thing that you can do is to understand the purpose for these metrics (as described above) and how they work out in reality. It is important to remember that each term will use these metrics to evaluate its staff differently. If you're working for one of the big four, expect these metrics (mainly utilization) to be a key component of your performance evaluation because you are just one of many staff members and the easiest way to measure you against everyone else and the firm's expectations is by the numbers.