The utilization and realization rates important performance measurement metrics of an organization. Both metrics are widely used for professional service organizations.
The utilization rate is a measure of internal efficiency and the realization rate is a measure of revenue recognition of an entity.
There are no set rules to define an ideal level for both these metrics. However, an entity can set standard benchmarks against historic records and industry practices.
Let us discuss what are the utilization and realization rates and key differences between both metrics.
Utilization Rate and Realization Rate – Definitions
The utilization rate is a percentage term that refers to the work hours billed against the total work hours available for a resource.
It shows how much time out of the total available is spent on billable hours. Therefore, it is important efficiency and productivity metric.
The realization rate is a percentage term that refers to the billed hours earned against the total billable work hours.
In practice, the realization rate is the ratio of the revenue received against the revenue earned by a company.
Therefore, the realization rate is also important efficiency and revenue metric.
Both terms are widely used by professional service organizations. Both terms offer insights into a company’s efficiency and productivity.
The utilization rate and realization rate link the profitability of a company. Utilization rate is the measure of efficiency in terms of utilizing the available time while minimizing idle time.
Similarly, the realization rate is the measure of revenue realized by maximizing the available billable hours.
How Utilization Rate and Realization Rate are Calculated?
Utilization and realization rates may differ greatly for professional service organizations depending on the size and nature of the work they undertake.
An organization can take a step-by-step approach to first calculate the utilization rate and then the realization rate using the same data.
- Calculate the total available work hours for the period. These hours can be calculated on a weekly, monthly, or yearly basis. Most organizations use the standard 2,080 hours for yearly calculations.
- Calculate the total billable hours worked by all employees one by one. This figure is calculated by deducting holidays, vacations, sick leave, non-billable activity time, and so on.
- Dividing the billable hours by the available hours gives us the utilization rate of the company.
- Next, the company can divide the actual billed hours (payment received) and the available billable hours to find the realization rate.
As we can see, calculating both terms takes a similar approach. A company can calculate both terms using the same data that mainly depends on the billable and total work hours available.
Formulas
Utilization Rate = (Total Billable Hours / Total Available Hours) × 100
Ideal Utilization Rate = [(Resource Costs + Overheads + Profit Margin) / (Available Hours × Target Billable Rate)] × 100
Realization Rate = (Total Billed Hours / Total Billable Hours) × 100
Example
Suppose a company ABC undertakes a project. It wants to calculate the utilization rate, realization rate, and adjust the pricing accordingly.
Assume that ABC company assigns the task to three employees. Total work hours available for them are 120, 100, and 80 hours respectively.
These employees worked for 105, 83, and 57 hours respectively on the project.
Therefore, the utilization rates for these employees and the project will be:
Employee1 Utilization Rate = 105/120 × 100 = 87.5%
Employee2 Utilization Rate = 83/100 × 100 = 83%
Employee3 Utilization Rate = 57/80 × 100 = 71.25%
Company Utilization Rate = (87.5% + 83% + 71.25%)/3 = 80.6%
Total Billable Hours = 105 + 83 + 57 = 245 hours Total Available Hours = 300 hours
Realization Rate = 200/245 × 100 = 81.63%
Ideal Utilization Rate and Realization Rate
A company achieving a utilization rate of 80% – 90% will consider itself an efficient organization. All companies would target a 100% realization rate, however, that cannot be achieved practically.
Let us continue with our simple example above to understand both concepts.
For simplicity, we assume that the work rate for all employees is the same at $ 50. Overhead costs are $ 5,000 and the profit margin is 30%.
The company estimates an ideal per hour rate of $85 for this project that covers the costs as well as the profit margin.
Therefore, the ideal utilization rate for the company will be:
Ideal utilization rate = (12,250 + 5,000 + 5,175)/ (300 × 85) × 100 = 87.94%
It means the company needs to work at 87.9% utilization rate to achieve its target profit margin and cover the project costs.
Since the company’s realization rate is only 81.63%, it would need to consider this factor as well. The company can either charge higher, reduce overhead costs, or improve its utilization rate.
Collectively, if the company improves its efficiency, its utilization rate and realization rate will improve.
Why Use Utilization Rate?
The utilization rate is all about the efficient utilization of the resources available for a company. A company has limited time and financial resources.
It means the company must utilize the human resources as well as possible.
Here are a few compelling reasons to use the utilization rate as a performance appraisal measure.
- It helps a company achieve resource efficiency by minimizing the labor idle and waste time.
- If the utilization rate is too high, it means the workforce is under pressure. Contrarily, a too low ratio means the workforce is underperforming.
- It helps a company manage staff strength and delegate duties accordingly.
- Using the historic data, a company can forecast its utilization rate and labor hours for future projects.
- Finally, it can help a company quote competitive prices and increase profitability.
Why Use Realization Rate?
The realization rate is an important revenue metric. It indicates the percentage of realized revenue against the total earned income.
A company must understand the real causes behind a lower realization rate. For instance, if a company fully charges its client, it may become costly and the client may refuse to pay.
Similarly, if a company’s utilization rate is lower, its realization rate would get affected. A lower utilization means, the company would need to charge higher realization to recover project costs.
Ultimately, the realization rate will also indicate improving the internal efficiency of the company. The company can improve its realization by increasing labor output, reducing idle time, reducing overheads, and adjusting its pricing strategy.
Utilization Rate Vs Realization Rate – Key Differences
The utilization rate is an efficiency and productivity metric. It shows how well a company utilized the available resources in terms of labor time.
The utilization rate also helps a company identify non-billable activities. It can differentiate between the billable and non-billable hours effectively.
On the other hand, the realization rate shows how well a company gets paid against the potential revenue earned.
Since many factors affect the pricing strategy of a company, therefore, it is impossible for a company to always charge an ideal rate and achieve 100% realization.
The realization rate also helps identify non-billable hours. Employees go through training, meetings, breaks, rework, and other similar activities that eat up billable hours.
In short, the utilization rate helps in improving internal efficiency and productivity. Whereas, the realization rate helps in improving revenue and profitability.
Since utilization and realization are derived using the same metrics, it is important to achieve a balance between the two.
For instance, when an organization’s utilization is too low, it indicates lower profitability and will result in lower realization as well.
Contrarily, a too high utilization would end up in a stressed workforce and compromised work quality. That again would result in a lower realization rate.
Therefore, an entity must strike balance between the utilization and realization rates.
Utilization, Realization, and Profitability of a Company
The bottom line of any business is its profitability. Proper management of the utilization and realization rates of an organization can lead to a profitable venture.
As mentioned above, both metrics must strike a balance to achieve optimum balance and profitability. If the gap between both metrics is too large, it means an entity’s efficiency is compromised.
A lower utilization means low efficiency and a further lower realization of profits. It indicates that the proportion of non-billable activities is too high.
It can also mean that the company didn’t assign skillful labor to the project tasks. Other reasons could be inaccurate project estimates, a lack of resources, inappropriate task delegation, errors in time-keeping, and so on.
An entity cannot control its client’s paying ability. However, it can increase its internal efficiency and improve planning to achieve better results.
An entity should aim to achieve a 100% realization rate. It can be achieved by setting competitive prices, submitting high-quality work, and efficient resource management.
Contrarily, a consistent high utilization rate may indicate negative repercussions for an entity. Either it means the workforce is consistently burdened or the task management of the entity is poor.
In short, an organization’s profitability is directly linked with both the utilization and realization rates. The aim should be to strike a balance between both metrics.
