Using financial statements to better manage your architectural practice
By Richard Hirschen, CPA
Gray, Gray & Gray, LLP
There are many ways to measure success in an architectural or engineering practice. Winning important and highly visible projects. Generating a steady flow of RFPs. Working on interesting and exciting designs. Being honored with awards and accolades. But none of these are meaningful – or even possible – if your practice is not profitable. The numbers must add up.
Which makes it essential that the primary yardstick of success must be the financial performance of your practice. The good news is that, by knowing where to look and how to analyze available data, you can quickly gain a reliable picture of the financial health of an architectural or engineering firm.
Using performance metrics that are culled from a firm’s financial statements and internal financial reporting systems, we can build a profile that accurately expresses a firm’s financial situation at any given time. More importantly, these numbers can be used to identify potential problems or possible opportunities for the firm.
What gets measured? Not surprisingly in a professional services business like architecture or engineering, the core metrics we look at are related to direct labor costs. In particular, we examine the ratio of direct labor costs to net revenue to make sure each project is being properly billed to maintain target profit margins. We also look at the ratio of direct labor to total labor to ensure the workforce is properly utilized.
We then ask questions such as, if margins are being eroded, why are they being eroded? Conversely, if a project is run efficiently and results in a strong profit margin, we want to identify the reasons to ensure the financial statements are accurate. If they are deemed accurate, then we want to understand how the project operated at such a high profit level so that we can apply this knowledge to other projects.
Metrics are valuable beyond simple profit and loss measurement. They can be used to determine such key ratios as revenue per employee, expenses related to labor costs, and in determining the most profitable billing rates.
We also focus on metrics that evaluate the operations of the company, rather than a specific project. These include the time it takes to collect receivables, debt service costs, and working capital needs. All contribute to the overall financial status of a firm.
How all these numbers are used is the key to improving financial performance. By gaining an accurate picture of the true financial status of a practice, management can make more accurate forecasts of annual performance, monitor performance on a monthly basis, predict cash flow and capital needs, and be more accurate in planning staffing needs. Perhaps the most valuable information that can be gained by analyzing financial results is the ability to quickly identify negative trends before they become serious problems.
All the information you need to perform a metrics analysis is already available. The secret is to have the know-how to identify the right numbers, and the discipline to perform and compare the measurements on a regular basis.
Richard A. Hirschen, CPA, is a partner with Gray, Gray & Gray, LLP Certified Public Accountants in Westwood, MA. (www.gggcpas.com)