Key Performance Indicators (KPIs) for Small Business Government Contractors

Key Performance Indicators are “Measures that help decision makers define and measure progress toward business goals. KPI metrics translate complex measures into a simple indicator that allows decision makers to assess the current situation and act quickly.” – KAIZEN Analytics All businesses, regardless of size, should to be able to understand and identify their Key Performance Indicators. KPIs can be used at all levels of an organization, ranging from the CEO to the project manager. The CEO focuses on the overall performance or health of the company, while the program or project manager may focus on single programs, tasks within a program, or a group of programs.

Types of Key Performance Indicators for Government Contractors

Some of the more common metrics used in government contracts are discussed below.

Revenue

Revenue is the total amount received in exchange for goods or services. It is the top line of the income statement from which expenses are subtracted to yield profit. Revenue recognition varies by contract type and by the revenue recognition method used (i.e. cost plus, accrual, percentage of completion, milestone, or other).

Revenue is a KPI for both internal management and for outside investors. Metrics for revenue may be in the form of revenue growth, which would compare revenue from a current point in time, to revenue from a prior point in time (year over year). The review of revenue is usually done on a year to date basis, comparing current year to date with budgeted year to date. Revenue may be compared to budget or plan at the company or program/project level.

The review of revenue should be done in a regular and timely manner to identify potential problems, and allow for proactive management.

Profitability

Profitability is the amount of revenue remaining after all expenses, directly and indirectly related to the generation of the revenue, are paid. Profitability is a key metric in the success of a business. A steady monthly profit is the result of good estimating, effective program management, and a reflection of the company’s ability to manage indirect cost. Profitability goals can be established at the program or at the company level.

Profit can be measured in total dollars or as a percentage (profit margin). The profit margin represents the percentage of each revenue dollar remaining after paying total expenses. Profit margin is measured by dividing total operating profit by total revenue. Total operating profit is total revenue less total expenses associated with a project including indirect expenses, amortization and depreciation.

Regular review of profit and loss by project can identify those projects that are not performing as planned and allow for program changes or adjustments to get the project back on track.

Days Sales Outstanding (DSO)

Days Sales Outstanding measures how long it takes to collect (on average) from your customers. This ratio shows the company’s liquidity and the efficiency in billing and collections. The sooner cash can be collected, the sooner the cash can be used for operations. Lower DSO results in an increase in cash flow and liquidity.

DSO can be measured monthly, quarterly or annually. DSO is calculated by dividing the ending accounts receivable by the total sales for the period, and multiplying the result by the number of days in the period. (Example: total receivables =$250K, total sales = $500K, and number days in the period =90. The resulting DSO in this scenario would be 45 days ($250,000/$500,000 x 90 = 45). The DSO goal is usually set on an annual basis.

As smaller companies grow and expand in the Cost Reimbursement world of government contracting, they can expect a higher DSO than previously realized in a T&M or FFP arena. A company that primarily utilizes T&M and FFP contracts may experience DSO of 45 days or less, while cost plus contracts may experience 75 to 90 days. A typical scenario might be that program costs are incurred for 30 days. It may take 5 days to close the month, and 10 days to gather the backup for the invoice and generate the bill. The payment cycle for the government may be 30 days if the invoice is fully documented and there are no discrepancies to resolve or questions to answer. The result would be a minimum of 75 days from bill to pay. Smaller companies should be aware of the increase in DSO for cost plus contracts and make provisions for any cash flow issues which might arise.

Indirect Rates or Wrap Rate

“Wrap rate” is the term used in government contracting to represent the multiple of a dollar which allows you to see how much you should charge for an hour of labor to cover your costs and profit. The wrap rate is determined by calculating current and future projections of direct and indirect costs (OH, Fringe, G&A). Effective cost management of indirect rates is critical to the profitability of your company. Proposing one wrap rate and realizing a higher wrap rate during the performance of a contract would mean that profit would be eroded on a T&M or FFP contract. The higher wrap rate on a cost-plus contract would mean the contract ceiling will be reached faster than proposed, forcing the government into a procurement cycle earlier than anticipated.  

Tracking the wrap rate using “actuals” may not be as effective as a stand-alone measure for a given point in time. This is because indirect rates should be evaluated on a cumulative basis of a fiscal year, since indirect rates are not streamlined from month to month. For example, more payroll taxes are expensed during the earlier part of a year before certain salary thresholds are met, which likely reflects a higher fringe rate earlier in the year. However, as the year progresses, the fringe rate will come down when lesser payroll taxes are required as salary thresholds are achieved.  Therefore, indirect rates should be tracked using “actuals,” plus a projection of future costs, to adequately reflect the end of year state.

Accounts Receivable Aging

Accounts receivable aging is a method of categorizing a company’s accounts receivable according to the length of time an invoice has been outstanding. Aging reports are usually broken down in 30 day increments and reflect total receivables that are due, as well as receivables that are past due. The aging reports may vary, but generally reflect 0-30 (current), 31-60, 61-90, 91-120 and 120+ increments. Companies with higher than normal collections should investigate the root cause of the slow payment. The aging may be due to invoice errors, lack of proper invoice documentation, or incorrect points of contact for accounts payable from the paying organization. A regular review of aged accounts receivable may indicate chronic late paying customers for which the company may decide the risk is too great to continue the business relationship or reveal the need to negotiate better payment terms.

Labor Utilization

Labor utilization is the tracking of the percentage of time your employees spend on direct or billable projects versus the amount of time spent on indirect or non-billable time. Labor utilization percentages can be measured in terms of labor hours or labor dollars. Labor utilization is directly linked to indirect rates and to revenue. The smaller your company, the higher the utilization number should be to cover your costs. Your company should establish the target utilization rate at the beginning of the year. Continued tracking of actual performance compared to budget can allow for adjustments to be made throughout the year.

Backlog

Backlog is the remaining funds left on each contract. Tracking backlog is important to keep from exceeding the funding limitations. The government is not obligated to pay if you continue to work with no additional funds. Thus, you are working at your own risk. Tracking backlog also allows for the contractor to be responsive with the notification of 75% funds expended, which is a requirement on many contracts. The 75% notification alerts the government that more funds are needed, and provides a timeframe for getting the funds in place. Backlog can be measured in terms of man-months by dividing the total funds remaining by the average revenue per month. The smaller the number, the quicker the company needs to respond by requesting additional funding or adjusting the schedule.

Pipeline

The pipeline is an ever-changing document reflecting future sales, near term opportunities, and win/loss ratio. The pipeline is not the same as a forecast. The forecast examines near term opportunities, while the pipeline is more of a top-level look at opportunities in various stages of the sales cycle, reflecting both the number of opportunities as well as the value of the opportunities. New opportunities should be added, lost opportunities removed, and values adjusted. The pipeline should be reviewed regularly by executive management to ensure the identified opportunities align with the strategic vision of the company, and to make sure the pipeline is growing. A static pipeline could indicate a stagnant business model.

KPI Tracking Tools and Assistance

There are multiple business intelligence tools on the market which promise real time data, easy search capability, and personalized visuals to monitor KPIs. For the small business, however, the purchase of additional software may not be the right solution due to cost, complexity, or integration issues with existing software. The metrics mentioned above can easily be assembled into a report format using data from your accounting system and Excel spreadsheets and graphics.

Redstone Government Consulting can assist you in the development of individualized KPIs for your organization based on the specific goals and objectives of your company. We can develop the spreadsheets and graphics for regular review and distribution. We also offer training for responsible managers to understand the drivers affecting the various KPIs and how to take proactive steps to achieve results using your KPIs.