Few would question how important it is for owners of architectural firms to track key business metrics consistently over time. However, often times they are too busy juggling the multiple demands of running a studio, or they lack the right tools to generate reliable, actionable financial information. Even if they do, the overwhelming number of metrics to look at can make it challenging to focus on those that really have an impact on the ability of the firm to drive sustainable, profitable growth.
In this post, we share our perspective on the three metrics that provide the most comprehensive picture of an architectural firm’s performance. Making savvy business decisions will no doubt require drilling down and performing additional analysis, but these are a good starting point to focus on.
1. Operating Profit on Net Revenue
Operating Profit on Net Revenue = Pre-tax, Pre-Distribution Profit x 100
Operating profit is a key metric because it shows how well management is doing at growing the firm’s profitability.
What increases operating profit is higher revenue, higher fees and having the right balance of staff. A constant stream of work that will maintain a healthy ratio of billable hours is also key. Even if individual projects are profitable, if there is significant volatility in workload all those “valleys” may be hurting the bottom line.
Overhead costs, labor in particular, are the largest expense for most firms. Tracking them to ensure they stay within target is crucial to ensuring sustainable profits over time.
How Does Your Firm Compare?
A/E firm operating profit margins on net revenue have been on a steady rise in recent years, reaching a six-year high of 14.3% in 2015, according to the 2015 A/E Financial Performance Benchmark Survey Report. "There are plenty of A/E firms that can and do deliver profit margins far higher than this. These are the firm leaders who are able to really think differently-about project delivery, about marketing strategy, about value. Deliver a higher value and you can command higher fees…and yield higher profits." says Frank A. Stasiowski, FAIA, Founder and CEO of PSMJ Resources.
2. Net Labor Multiplier
Net Labor Multiplier = Net Revenue
Direct Labor (cost of labor charged to projects)
The Net Labor Multiplier shows how many dollars the studio generates per dollar spent on direct labor.
IT increases with higher fees and billing rates or higher overall revenue. Labor costs including salaries and bonuses also impact this metric. Closely monitoring budgets and schedules at the project level can help detect deviations early on and ensure direct labor costs are within target.
When making decisions that impact direct labor, consider all costs involved including recruiting, onboarding and lost revenues. Higher competition for resources as a result of industry growth means retaining key staff is more important and cost effective.
Some Project Management software platforms calculate Direct Labor automatically by combining time tracking records with staff rates. The NLM is then calculated by factoring in Net Revenue, and this is a key metric included in dashboards and reports.
3. Cash Flow
Cash flow is a measure of how much money the firm has at any time to pay accounts payable: employee salaries, taxes, insurance premiums, reimbursable expenses, subconsultants’ fees, and expenses.
Even if a firm is profitable, cash flow can become a serious challenge for architectural firms and can negatively impact its ability to meet its obligations to staff, vendors and consultants.
A monthly cash flow report and 12-month cash flow projection can help plan ahead to maintain a healthy cash flow by requesting a down payment prior to starting a project, accelerating collection and carefully planning purchases. Leveraging by tapping to credit is helpful and a good business practice as long as the cost of credit is significantly lower than the return.
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