15 Crucial Financial Metrics for Architectural and Engineering Firms
You Don’t Have to Be a Whiz to Know These Buzzwords
Investors in the stock market obsess over buzzwords like earnings per share and revenue growth. In addition, you can find many other metrics in a company’s financial report. These financial metrics tell a story about the company. It can be a positive story and paint a rosy picture about the company’s future, or it can make us worry that the company might not make it.
In any event, this applies to all businesses and not just big companies. Different industries have different sets of metrics that we should pay attention to. We have identified the most important metrics that all architectural and engineering firms should keep track of.
The first step is to keep all financial records organised. After that, you’ll be able to look up these metrics. Things can get even simpler with the help of enterprise resource planning (ERP) software. What’s more, affordable ERP software products are now available for businesses of all sizes.
Ask your Accountant or Bookkeeper to calculate these metrics for you so you can keep a track on them.
Here are the relevant financial metrics for architectural and engineering firms:
Metric #1 – Overhead Rate
The overhead rate is the ratio of total indirect expenses to total direct labour. You can calculate overhead rate as a ratio or as a percentage of total direct labour.
For an architectural or engineering firm, indirect expenses are all expenses unrelated to projects. This amount is higher than total direct labour even for the most efficient architectural firm. Therefore, the overhead rate for the architecture and engineering (A&E) industry is over 100%. The trick is to keep the overhead rate in check. This is because it has a direct effect on the firm’s profit margin.
The target overhead rate is 150 to 175%. According to the 2017 Deltek Clarity A&E Report, the A&E industry has seen lower overhead rate five years in a row. The 2016 industry average is 154%.
Metric #2 – Utilisation Rate
The utilisation rate is the ratio of total direct labour to total labour. You can calculate utilisation rate as a ratio or as a percentage of total labour.
For an architectural or engineering firm, direct labour is the labour that a firm spends on billable projects. The utilisation rate is a measure of how well the firm utilises its labour. It is however not a measure of productivity. An efficient firm would use a higher percentage of its labour to generate revenue.
The desirable utilisation rate is 60 to 65% if it covers all staff. Otherwise, it is 75 to 85% for just the technical staff. Training can enhance a firm’s utilisation rate. For example, a new hire is more ready to work on billable projects after completing advanced Revit training.
Metric #3 – Net Multiplier
The net multiplier is the ratio of net revenue to total direct labour.
An architectural or engineering firm’s net multiplier is the return on investment (ROI) for the money spent on direct labour. A net multiplier of 3 means the firm is getting three times back in revenue. It is an indicator of the firm’s profitability.
There is a net multiplier that every industry has to hit in order to have a healthy profit. For the architecture and engineering industry, it is 2.75 or higher. According to the 2017 Deltek Clarity A&E Report, the average net multiplier for the A&E industry is 3.02. This average increases to 3.50 for the top-performing firms.
Metric #4 – Break-even Rate
The break-even rate is overhead rate + 100%. If the overhead rate is in ratio, then it would be an overhead rate of + 1.
The mathematical expression of + 100% or + 1 means adding direct labour to overhead rate. Therefore, the break-even rate shows us how much the firm has to gross above its labour cost to break even. We can apply the break-even rate either to the firm’s total labour cost or to each employee’s salary. For example, if the break-even rate is 250% and an employee’s salary is $50,000, the firm has to make $125,000 in revenue to break even.
The break-even rate ties to the overhead rate. Considering that the desirable overhead rate for the architecture industry is 150 to 175%, the break-even rate should be 250 to 275%. The break-even rate must be lower than the net multiplier for the firm to turn a profit.
Metric #5 – Backlog
The backlog is the value of the unbilled portions of existing fee contracts. It is also known as revenue backlog.
The backlog of an architectural firm is revenue in the pipeline. A&E firms commonly express backlog in terms of total value, months, and backlog per employee. You have to continuously update this metric, since new invoices subtract from the backlog and new contracts add to the backlog.
The target backlog is equal to or higher than the firm’s annual operating expenses. If the backlog continues to build up, the firm would have to add to its operating expenses, such as expanding the workforce. If the backlog falls off, the firm may have to reduce its operating expenses.
Metric #6 – Aged Accounts Receivable
The aged accounts receivable is the average accounts receivable divided by net operating revenue per day. Therefore, the unit of this metric is days.
First of all, there are several ways to determine average accounts receivable. One way is to add up end-of-month accounts receivable for the past 12 months and divide by 12. The aged accounts receivable is the average number of days that a firm has to wait for payment. This is a rough average because calculating average accounts receivable is not an exact science.
A&E companies in the A&E industry should collect on an invoice within 60 days. Beyond that, unpaid invoices exceeding 90 days become worrisome. If you can collect on most invoices within 60 days, the aged accounts receivable will be less than 60 days.
Metric #7 – Pending Proposals
The pending proposals are the dollar amount of all proposals in the work.
It is up to the marketing department to evaluate each pending proposal. There should be a good mix of proposals where the firm has a 50% or higher chance of winning and proposals with less than 50% chance of winning.
A good target is pending proposals totalling 2.5 to 3 times the firm’s annual net revenue. At least one-third to half of the pending proposals should be ones that the firm has a 50% or higher chance of winning.
Metric #8 – Personnel Expense
The personnel expense is an additional labour cost. This includes payroll taxes and employee benefits such as vacations, sick leave, and pensions.
Although a firm’s personnel expense is part of the overhead cost, the common practice is to account for this expense separately. This makes it easy to track. Furthermore, you can average the total on a per employee basis. Then you can easily include personnel expense in project costing.
The acceptable level of personnel expense varies according to location. You will notice that most employee training costs are negligible compared to personnel expense. Advanced Revit training at ArchiStar Academy, for example, is highly beneficial yet affordable.
Metric #9 – Ratio of Profit to Revenue
The ratio of profit to revenue is profit divided by net revenue. Note that this is profit before taxes and distributions.
In the A&E industry, the ratio of profit to revenue is a measure of how well a firm manages its projects. An architecture firm can control this ratio better with cost-plus contracts. However, fixed-price contracts offer higher potential ratio of profit to revenue. For this reason, many top performers prefer fixed-price contracts.
The target ratio of profit to revenue is 10% or higher.
Metric #10 – Current Cash Flow
The current cash flow is the cash that a firm has on hand to meet financial obligations.
A firm’s current cash flow may not be the same as its ability to turn a profit. This is because meeting monthly financial obligations can be a challenge even for firms that are profitable on paper. The most direct way to increase current cash flow is stepping up collection of accounts receivable.
An architectural firm should keep enough current cash flow to meet financial obligations for more than one month. A line of credit is a good backup for times of temporary shortfall.
Metric #11 – Current and Long Term Assets
Assets are a major component in the balance sheet. Assets consist of current and long-term assets.
Current assets are cash and assets that a firm can convert to cash within the next 12 months. All other assets are long-term assets. Computer software is also a long-term asset. As an example, software purchased from ArchiStar Academy stays on your balance sheet, and you can expense the cost of advanced digital design training and other courses.
In the A&E industry, the biggest current asset is accounts receivable. All in all, it is good to have current assets twice as valuable as the firm’s financial obligations in the next 12 months.
Metric #12 – Collection Period
The collection period is the number of days it takes to receive payment for an invoice.
A firm’s collection period affects its current cash flow. It is important to manage the collection period of accounts receivable since cash flow is often one of a firm’s top financial concerns. According to the 2017 Deltek Clarity A&E Report 2, average collection period of less than 60 days has become a thing of the past for the A&E industry. Instead, it has risen to 72 days in 2016. However, top performers in the industry reported lower-than-average collection period.
Metric #13 – Contract Type
The two types of fee contracts are cost-plus contracts and fixed-price contracts. A cost-plus contract is variable according to the amount of time and resources an architectural firm puts into the project. But a fixed-price contract does not change for the duration of the project.
Many top-performing firms prefer to work with fixed-price contracts. Although cost-plus contracts carry lower risk, its profit stays at a fixed margin. In contrast, much higher ratio of profit to revenue is possible with fixed-price contracts.
Metric #14 – Revenue Per Employee
The revenue per employee is annual net revenue divided by the number of employees.
An architectural firm’s past revenues per employee are a good indicator of what future revenue to expect. A firm’s hiring plan should not depend solely on its revenue per employee. Adding to the workforce may not increase revenue proportionally. Conversely, reducing the workforce may not always translate to higher revenue per employee.
There is no firm revenue per employee target in the A&E industry except the higher the better. All top performers in the industry have higher-than-average revenue per employee.
Metric #15 – Billable Utilisation
The billable utilisation is the ratio of billable hours to total hours.
All in all, the billable utilisation shows how well the firm utilises its resources. It does this on three levels. Firstly, at the company level this is the same as the utilisation rate. At the project level, it shows how well the project manager is managing the project. This can translate to higher or lower profitability. At the employee level, the firm uses this metric to evaluate each member of the technical staff.
The Final Word
You can find many of the above metrics in your firm’s income statement and balance sheet. Monitor these metrics to ensure that your firm is heading in the right direction. You should observe both the current metrics and their development over time. If you can spot the warning signs early, you might only have to make small changes instead of taking drastic measures.
Training can improve your firm’s financial metrics. For one, it prepares the technical staff and makes them always ready to contribute. The firm’s utilisation rate can only go up as a result. It will boost revenue per employee. This in turn increases the net multiplier, which is an indicator of profitability. All is good when profit goes up!
ArchiStar Academy offers several levels of online courses that helps firms win new projects and design faster. On average our members report they save 4.4 design hours per week. Contact us today for more information.
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Posted on 10 Dec 2018