The A/E/P and environmental consulting business is really pretty simple from a financial management standpoint. It shouldn’t be hard to track the numbers you need to run a firm, yet so many companies seem to struggle with it.Most firms— especially those with 50 or fewer employees— don’t seem to know much on a monthly basis beyond their employee utilization rates (and most of these are based on hours instead of dollars), what they billed, what they collected, and what they spent. This information is then shared only between the owners or key managers. Then, when the firm discovers it has run out of work because its billings are down, or even worse, the firm runs out of cash and credit, they cut staff.Even large firms have a hard time collecting and distributing the right numbers to their people so the firm can avoid huge peaks and valleys performance-wise. It seems like everybody makes this whole process a lot harder than it has to be. What numbers should a company track on both a monthly and year-to-date basis? Here are my thoughts:Number of inquiries from clients. This is a very important number that only a handful of companies actually track. I am referring to the total number of times the phone rang and the number of letters or RFPs that came into the firm at month end. These may or may not have to do with any specific project. This is the very first indication of whether or not the firm’s marketing efforts are accomplishing anything. Number of projects the firm is pursuing and their net service revenue dollar value. These numbers are also important indicators of what the future will likely bring. Track the total number of projects your firm is pursuing at the end of each month (is it 4, 40, or 400?), as well as the total estimated dollar value of this work (in labor or service revenue value). Number of proposals submitted and their net service revenue dollar value. To get these two numbers, total up every job your firm has actually submitted a proposal on at month end. Each will always be less than the numbers mentioned in item #2 above, but they are also very important indicators of what the firm’s future workload will be. Net service revenue dollar value of work sold. I define a “sale” as a job you can work on. And “net service revenue dollar value” is what your firm is going to get from the job— it doesn’t include subconsultants, reimbursables, and ODCs (other direct costs). Usually, recording a “sale” means you have a contract and notice-to-proceed. But there could be times when an established client says “go to work” and there is no contract, yet you know the job is real. The bottom line is you need to know what you’re selling if you are going to be ready to either produce the work or reduce your expenses before disaster strikes. Net service revenue. “Revenue” means what you earned on your jobs, which is not necessarily the same as “billings.” There are many ways to calculate revenue. Hourly jobs are simple— it’s the number of hours charged to the jobs multiplied by individuals’ billing rates or cost rate with overhead and profit added. Fixed-fee or percentage-of-construction-cost jobs are another matter. Larger projects of these types require a continual effort to estimate percentage completion, which determines the revenue recognized on the project. I prefer to calculate the revenue for smaller fixed-fee or percentage-of-construction-cost projects by using standard billing rates multiplied by hours worked, and adjust revenue up or down at the end of the project by writing off or writing up work-in-process (WIP). Net service revenue billings. This is also called “labor billings.” It’s the total of all of the firm’s invoices sent, less subconsultants, reimbursables, and other direct costs. Net service revenue collections. This is simply the cash that came in for labor billings. Most companies track collections, but they don’t know how much of this money is theirs versus how much has to go right back out the door for subconsultants and reimbursables. The result is that they have an inflated idea of the real volume of their business. Average collection period (ACP) in days. Take total accounts receivable (including subs and reimbursables) at the end of the month and divide by the average daily billings for the firm to calculate average collection period. This is a number that any firm should be trying to drive down. ACP is an indication of how effective a firm is at collecting its money. Utilization rate based on dollars. Most companies track this number based on hours, although we are starting to see more firms looking at it on a dollars basis these days. Calculate utilization rate by dividing direct raw labor dollars by total raw labor dollars. This number will almost always be 3-5% lower than it would be if you calculate it by dividing direct labor hours by total labor hours. The danger in over-emphasizing utilization is that it may encourage people to be inefficient on their jobs— in other words, it is simply an indication of how well you consume man-hour budgets. Effective labor multiplier. Take net service revenue and divide it by direct raw labor dollars. This is effective multiplier. This is not the same as “targeted multiplier.” Effective multiplier is how you actually performed; targeted multiplier is how you hoped to perform. The danger in over-emphasizing multiplier is that it encourages people to work on projects and not charge their time to the project. This is called “protecting” the job. Revenue factor. Calculate this by multiplying utilization rate and effective multiplier, or by dividing net service revenue by total raw labor. This is an extremely important number! I’d rather you calculate this than utilization or effective multiplier— each of those figures only tells half of the story. Revenue factor also puts all work groups or offices on the same footing. For example, a construction services group with a 90% utilization rate and 2.1 multiplier is doing better financially than an engineering group that’s 63% billable at 2.8. Revenue factors would be 1.89 and 1.76, respectively. Yet some firms don’t understand this! They either look at multiplier and say, “We can’t make money on a 2.1,” or, they look at utilization and say, “Joe’s group is the top performer; they have 90% billability,” when another group may be only 50% billable, but have a 4.2 multiplier and a revenue factor 20 points higher than Joe’s. Profit on both a cash and accrual basis. These numbers are self-explanatory. Look at both; both are important. If you over-emphasize accrual, it will result in no one worrying about collections. Over-emphasize collections and no one will worry about what it takes to create the receivable in the first place. Total of cash in all accounts and accounts receivable, less current line-of-credit balance and current accounts payable. This number is always interesting to plot out, especially when you look at it over time. Very few firms look at it, but it is an excellent indicator of the firm’s financial health. A running, 8- to 12-week cash flow forecast. Not one of the project management/firm management cost accounting packages that are designed for our industry has a standard report that provides this information. Yet, from a short-term survival point of view, this is essential! All you need to do is assign an anticipated date of collection to every bill you send out, and schedule payment of all accounts payable and recurring expenses for rent, labor, leases, insurance, and so on. Put all of this in a spreadsheet and then discover shortages or surpluses on a week-by-week basis. Push out payables, if necessary, and speed up collections where possible to eliminate any shortfalls before they occur. Tracking, reporting, and sharing the right numbers takes 98% of the mystery out of running an A/E/P or environmental firm. This isn’t just a bunch of unnecessary mumbo-jumbo that adds to overhead. All this data should serve a valuable purpose— to predict what is going to happen before it does so you can refine the performance of your entire firm.Originally published 6/03/1996
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