What is cost recovery analysis?

Cost recovery analysis examines whether revenue from services covers all associated costs, including direct costs, overhead allocation, and target profit margin. For professional service firms, this analysis reveals whether pricing and delivery achieve full cost recovery or whether the firm effectively subsidizes certain services or clients.

Key characteristics

• Compares revenue to all associated costs

• Includes direct costs and overhead allocation

• Reveals whether the full cost is recovered

• Identifies subsidized services or clients

• Informs pricing and delivery decisions

• Should be performed by the service line and the client

Why it matters for professional service firms

Revenue does not equal profitability. A service generating $300K revenue with $280K in full costs recovers 107% of cost (profitable). One generating $300K with $340K in costs recovers only 88% (unprofitable despite significant revenue). Professional service firms should analyze cost recovery by service line and major client, and take action on persistent under-recovery through pricing adjustments or cost improvements.

Real-world example

Lisa's firm had three service lines, all showing positive contribution margin. Cost recovery analysis including full overhead allocation: Service A recovered 118% of full cost (highly profitable), Service B recovered 102% (marginally profitable), Service C recovered 87% (unprofitable when overhead was considered). Service C had been considered profitable based solely on direct costs. Actions: Service C pricing increased 12%, delivery streamlined to reduce hours, and unprofitable clients transitioned. Service C recovery improved to 98% within two quarters.