What is Realization Rate and How to Calculate It?

Realization rate is the ratio of your worked hours against your paid hours. It means it is the difference between the time worked on a project against the time you get paid for.

It is a simple percentage term that indicates how much a company is earning against its worked hours. It can be used to improve internal efficiency as well as to set the right pricing with the clients.

Let us discuss what is the realization rate and how to calculate it.

What is the Realization Rate?

Realization rate is the ratio of billable work hours against the hours paid by the client.

In other words, it is the ratio of theoretical revenue against the actual revenue earned by a company.

Professional service organizations need to calculate realization rates to estimate their actual profitability as opposed to their calculated profitability.

Realization rate is a productivity and performance metric of a business that shows a company how well it is utilizing its human resources and its available time.

A company may work on a commercial project. It would then assign its human resources and set a time limit to complete that project. The utilization rate is an effective performance measuring metric that shows the difference between the standard billable hours and the actual bill hours paid by the client.

The difference may arise due to several reasons including inefficiency, the inexperience of employees, inaccurate capacity utilization, discounts, and so on.

Realization Rate Formula

Realization rate is a percentage term that can be calculated by dividing the total billed hours by total billable hours

The formula to calculate the realization rate can be written as:

Realization Rate = (Total Billed Hours / Total Billable Hours) × 100

The same formula can be used to calculate the realization for all employees of a company. It can then be used to calculate the total realization rate of the company.

It is important to note that the total billable hours are different from the total available hours. For better results, a company may include its billable and non-billable hours.

How to Calculate Realization Rate?

The realization rate requires calculating the total number of billable hours of a company. These hours are the sum of worked hours for all employees of a company.

Billable hours are different from the total available hours for a company. Usually, companies would use an annual figure of 52 (weeks) × 40 (hours) = 2,080 hours. However, since there are roughly two weeks off annually, so many companies also use a figure of 50 (weeks) × 40 (hours) = 2,000 hours.

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Here is a step-by-step approach to calculating the realization rate.

STEP 01:

Calculate the total available hours for an employee for the accounting period. This period can be a year or month depending on your analysis.

STEP 02:

The next step is to exclude non-billable hours from the total hours. The resulting figure will give you the total billable hours.

Non-billable work hours can include:

  • Entitled yearly leave; paid and unpaid
  • Sick leave days
  • Estimated internal activities; non-working
  • Professional development days (Training)

STEP 03:

Then, calculate the billed hours for your company. These are the hours that are actually paid for by the client.

In other words, calculate the actual rate per hour after receiving the payment.

STEP 04:

Divide the total billed hours by the total billable hours to get the realization. Multiply the resulting figure will be your realization rate in percentage terms.

For consistency, use the same metrics from the same accounting period. For instance, if you are using the total billable hours for one year, choose the billed hours for the same period as well.

Realization Rate for Individual Employees and the Company

Most companies use the standard benchmark of 40 hours weekly. Suppose an employee worked for 40 hours but deductions for lunch and off-time mean the total billable hours for the employee were 35 hours.

It means the utilization capacity rate for the employee is 87.5%. Now, let us assume the company calculated a $ 70 per hour rate for a project.

Theoretically, the company should receive $ 2,450 for that project. However, the client may be unwilling to pay that cost or the company may assume that quoting that price would affect the client relationships.

Suppose the agreed price for the project is $ 2,000. Then, the realization rate for that employee will be:

Realization Rate = (2,000/2,450) × 100 = 81.6%.

It means the company has realized only 81.6% of the total available revenue. However, it does not mean that the company incurred a loss. There are several factors that affect the utilization and realization rates of a company.

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The company can use the same approach to calculate the utilization rates for all of its employees.

Example

Suppose a company has five employees working on a project. It wants to calculate the realization rate for the company for the period of that project only.

It has the following data available regarding the work hours of its employees working on the project.

  • Total Available hours for the project (Billable) = 180
  • Total Billed hours for the project = 160                  
  • Non-Billed Hours = 20

The realization rate for the company can be calculated using the formula:

Realization Rate = (Total Billed Hours / Total Billable Hours) × 100

Realization Rate = (160/180) × 100 = 88.8%

What is an Ideal Realization Rate?

Every company would like to achieve a 100% realization rate. It means every company would like to charge the fullest amount it calculated on per hour basis.

However, it cannot be achieved in practice as it makes the pricing uncompetitive. Also, a company’s employees may be inexperienced or unskilled for the project requirements which could result in a lower realization rate.

A low realization rate may be caused due to several factors.

  • The company assigned inexperienced employees to the project that took longer than expected to complete the assigned tasks.
  • The company could not track the billable and worked hours correctly.
  • The company may want to write off some billable hours to keep the pricing competitive.
  • The client may refuse to pay for the full hours as a dissident or as a request for a discount.

Similar several other internal or external factors can affect a company’s realization rate. The most important factor remains the company’s efficiency and productivity levels.

Why Use Realization Rate?

Realization rate is an advanced approach to calculate the efficiency and productivity of a company as compared to other metrics.

Every company would like to know how its employees are performing. Professional service organizations specifically need to calculate the realization rates so that they know their efficiency levels.

The realization rate also helps a company to company to account for its non-billable working hours. Once it calculates all the available hours, it would then account for the actual billed hours.

This approach would create a cushion for non-billed hours. Using this approach, a company would then adjust its profit margins and improve internal efficiency.

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Adding non-billable hours in the calculations means an employee’s total working hours are considered. An employee may work on capacity-building activities like training or work on other office tasks.

The only caution a company should take is to consider the total billable and non-billable hours. The total of these two will be different from the total available hours that are usually set at 40 hours per week.

How to Improve Realization Rate?

It is inevitable to find a lower realization rate than 100%. A company would face several issues that would reduce its efficiency and productivity.

The realization rate would also be lower to keep the pricing strategy competitive. However, a company can take a few measures to improve its realization rate.

Showcase the Time Value

If a company simply sends an invoice to its clients listing the total worked hours on a project, chances are the clients would want to reduce those figures.

Taking a proactive approach to showcase the time value of your employees spent on a project would increase the chances of billing the full worked hours.

Use Proficient Employees

Assigning junior and inexperienced employees to a project can reduce efficiency and increase the time taken to complete a project.

Professional service organizations should carefully assign employees that possess the necessary experience and skills to complete complex projects.

Assigning the right employees for the right job increases efficiency and the realization rate effectively.

Implement Billing Guidelines

A professional service organization would implement internal policies and guidelines for recording its billing time. However, many corporate clients also issue billing guidelines that a service provider must follow.

A professional service organization must strictly adhere to these guidelines otherwise the client may ask for the exclusion of certain tasks or a reduction in the total price of the project.

Use Different Pricing Strategies

Another defense for a professional service organization is to use alternative pricing strategies.

For example, a company may use a flat-rate pricing strategy instead of charging hourly rates. However, it should take its clients in confidence to retain their trust and good working relations.

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