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Financial Management for the Small Architectural Firm 201 – Terminology and Examples

burns@bqe.com'

 

In my previous article I made the strong case as to why your small firm needs to think like a business and not just like an architect. Your financial health starts with creating an Operating Budget – also known as a Profit Plan.  Why a profit plan? Because you’re in business to make money, that is profit. Remember; no profit equals no business.

I’m going to share with you how to develop the simplest, most bare-boned version of a Profit Plan that is helpful to any small or emerging firm. So grab a pencil, a piece of paper and a cup of coffee. Turn off your email and silence your phone. This is dry material for an architect but important information you need to know.

There are three steps you need to do when creating a profit plan:

Step 1:   Estimate your expenses. Don’t include any of those that are reimbursed by your client (e.g., printing, travel, pass-through consultant fees, etc.).

Step 2:   Set a Profit Goal. This is generally thought of as your return on investment (ROI). It’s a percentage of your total expenses. All the effort, and money, you put into the business should return you a profit. This is what you would expect if you invested the money in something else like stocks, bonds or real estate. What’s the return you want to see? I recommend 20%. Otherwise, take the money and invest it in the stock market. You’re also pouring your life into these projects so the return should be commensurate with the effort.

Step 3:   Add your expenses with your Profit Goal to get the Net Revenue Goal. This is called Net because it doesn’t include those reimbursable expenses I mentioned earlier. Your Net Revenue Goal is what you plan to invoice your clients for your services. In the sample profit plan shown below, the Net Revenue Goal is $500,000.

SAMPLE PROFIT PLAN      
5 Person Firm
SALARIES
Principal (1 @ $100,000)

 $100,000

Project Architect (1 @ $70,000)

 $75,000

Intern Architect (2 @ 35,000)

 $70,000

Office Administrator (1 @ 25,000)

 $25,000

TOTAL SALARIES

 $270,000

PAYROLL TAXES AND BENEFITS

 $30,000

OFFICE EXPENSES
Rent

 $50,000

Utilities

 $5,000

Telephone

 $2,000

Equipment Purchase/Maintenance

 $12,500

Postage/Shipping

 $1,000

Publications

 $667

Insurance (Auto, General Office, Liability)

 $12,500

Office Supplies

 $5,000

Travel

 $6,000

Printing

 $7,000

Marketing Tools

 $10,000

Miscellaneous

 $5,000

TOTAL OFFICE EXPENSES

 $116,667

TOTAL EXPENSES

 $416,667

PROFIT GOAL (20% x Total Expenses)

 $83,333

NET REVENUE GOAL

 $500,000

 

Reaching Your Profit Goals

Now that we have created our Net Revenue Goal of $500,000 we need to understand where this revenue is derived. Architects earn their revenue (and profit), by working on projects. So it should come as no surprise that the most common denominator for planning and measuring financial performance is the Direct Salary Expense (DSE). This is the salary cost of the hours charged to projects (your billable time).

We can actually use the sample profit plan to easily calculate our DSE multipliers. These are the numbers that will be used to determine the values such as the target break-even, profit and revenue amounts. But in order to do this we need to know our Efficiency Ratio.

Efficiency Ratio = Direct Salary Expense / Total Salary Expense

Or

Direct Salary Expense = Total Salary Expense x Efficiency Ratio

So how do we know the efficiency ratio for your firm? Well, I don’t. But there are statistical surveys which show that, on average, architectural firms achieve about 65%. This averages all employees (principals and all employees). While Principals may only be 50% efficient (spending 20 of their 40 hours/week billable on projects), Interns may be 95% efficient. Please, no comments about the 40 hours/week. I know, I know.

Time Billing Software

So let’s modify the sample profit plan above by making adjustments to acknowledge our estimated efficiency ratio:

SAMPLE PROFIT PLAN
Using 65% Efficiency Ratio
DIRECT SALARIES ($270,000 X 0.65)

 $175,500

INDIRECT EXPENSES
Indirect Salaries ($270,000 x 0.35)

 $94,500

Payroll Taxes and Benefits

 $30,000

Office Expenses

 $116,667

TOTAL INDIRECT EXPENSES

 $241,167

TOTAL DIRECT SALARES + INDIRET EXPENSES

 $416,667

PROFIT GOAL (25% x Total Expenses)

 $83,333

NET REVENUE GOAL

 $500,000

In the chart above we know that our Total Salary is $270,000. But since we have a 65% efficiency ratio – our Direct Salary Expense is $270,000 x 0.65 = $175,500.

To Pay for DSE:                       $175,500 / $175,500 = 1.00

To Pay for Indirect Expenses: $241,167 / $175,500 = 1.37

Combined, these give you the Break Even Multiplier of 2.37

 Now, you’ll want profit:          $83,333 / $175,500 = 0.47

Therefore, your Planned Net Multiplier is 2.85. This is that magic number, specific to your firm.

Setting Ideal Billing Rates

The Planned Net Multiplier is an incredibly important number to help you determine what the minimum hourly billing rates should be for your staff. So let’s take a look at each staff member:

COST RATE AND IDEAL BILL RATE

Principal

Project Architect

Architect Intern

Gross Annual Salary

$100,000

$75,000

$35,000

Payroll Tax (15%)

$15,000

$11,250

$5,250

Health Insurance

$8,000

$4,000

$4,000

Retirement Plan

$3,000

$2,250

$1,050

Net Cost/Year

$126,000

$92,500

$45,300

Gross Hours/Year

2,080

2,080

2,080

Vacation

(120)

(80)

(80)

Holiday/Personal Leave

(80)

(80)

(80)

Net Hours Worked/Year

1,880

1,920

1,920

Net Cost Rate/Hour Worked

$67

$48

$24

Planned Net Multiplier

2.85

2.85

2.85

Ideal Billing Rate

$191

$137

$67

As long as your office maintains the 65% efficiency rate you must bill your Principal at $191/hour, your Project Architect at $137/hour and your Architect Interns at $67/hour to obtain the desired profit.

Granted, some firms don’t like to look at the global efficiency rate, opting instead to evaluate the Ideal Bill Rate for each employee based on their true efficiency levels. But that’s a discussion that I don’t want to get us involved with at this time.

The final exercise we’ll do at this stage is to calculate the Projected Realizable Income from each of our employees.

Potential Realizable Income

Principal

Project Architect

Intern 1

Intern 2

 Total

Net Hours Worked/Year

1,880

1,920

1,920

1,920

Actual Efficiency Rate

50%

75%

90%

90%

Billing Rate

$200

$125

$75

$75

Realizable Income

$188,000

$180,000

$129,600

$129,600

$627,200

As we can see, the Total Realizable Income of $627,200 is greater than the $500,000 we projected in our Profit Plan. In order to achieve the profit plan we only need to invoice 80% of our potential. This is a very common position for most firms. Obviously, we would like to bill the full potential and hopefully you will. Considering that the Principal will be spending half of his or her time working on non-billable things we would hope that these efforts are what will continue to bring new work into the firm.

Our next installment will be to discuss the practical applications of your office financial management.

About the Author: Steven Burns, FAIA, spent 14 years managing his firm Burns + Beyerl Architects. After creating ArchiOffice®, the intelligent office, project management and time tracking solution for architectural firms, Steve brought his management expertise to BQE Software, where he is perfecting the business strategy and product development.

burns@bqe.com'
Steven Burns, FAIA

Steven Burns, FAIA, is the “recovering architect” creator of ArchiOffice, who now serves as the Director of Product Strategies for BQE Software, Inc. He spends his time herding cats and keeping his team focused on creating the smartest time billing and project management software available for architects.

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