April 9, 2013
Driving Profitability – Four Important Metrics for A/E Firms
People commonly link the architectural and engineering (A/E) industry with the construction industry. Although it is true that many of the same global, national, and local economics drive the demand for both of these industries, that is where the similarities end. Once the work comes in the door, these two businesses are managed quite differently, especially when it comes to financial management. The drivers of profitability are quite different for a construction firm than for an A/E firm.
There are several financial metrics that A/E firms use to manage their business. These important metrics often are included on internal financial statements, executive scorecards, or dashboard reports. The metrics often focus on the core areas of performance, liquidity, future work, and value. Four key performance-related or income statement metrics are discussed below.
1. Net Multiplier. This indicator represents the amount of net revenue being generated per labor dollar (net revenue/direct labor dollars). The higher the multiplier, the more net revenue being generated by your direct labor base, which often translates to higher profitability at the project level. The goal of most businesses is to generate as much quality revenue with as little effort as possible to maximize profitability, so the higher the ratio the better.
2. Utilization Rate. This metric compares the percentage of time your professional staff spends working on billable projects with total hours worked (total billable hours/total hours worked). This ratio typically is used to evaluate capacity and current work-in-process levels. Generally, the higher the ratio, the more billable your professional staff will be. Burnout and fatigue can result, however, if the ratio is too high and continues for an extended period of time.
3. Revenue Factor. This ratio takes the net multiplier and utilization rate metrics and plays them against one another (net multiplier x utilization rate). This is the best measure of a firm’s efficiency and a significant driver of profitability.
Net multiplier and utilization rate metrics can be gamed or manipulated to achieve goals and objectives, but still can result in negative consequences to the bottom line. For example, the utilization rate can be artificially driven upward by individuals charging too much or spending too much time on projects. While this increases the utilization rate, it has a detrimental impact on the net multiplier. The opposite can happen if people try to manipulate the net multiplier upward by not charging all their time to projects, resulting in the utilization rate decreasing.
Multiplying these two ratios allows for a cleaner evaluation of a firm’s overall efficiency and helps to balance net revenue and labor.
4. Overhead Rate. The first three metrics focus primarily on profitability or margin generated from projects. However, it is critical for a firm to manage its nonbillable labor (indirect labor) and other overhead costs in order to maximize net income from year to year. The overhead rate is one of the key metrics used in evaluating total overhead costs. The overhead rate is measured by comparing the total overhead costs (including all nonbillable labor) as a percentage of total direct labor (total overhead/total direct labor). Ideally, the goal should be to drive this rate down as low as possible so that you maximize the revenue of every overhead dollar spent.
Every firm is different, so the goals and benchmarks that should be established for these financial measures will vary by company. The metrics discussed here, however, are essential to successfully managing the profitability of an A/E firm. It is critical that goals be determined in each of these areas and tracked, reported, and evaluated on a regular basis so that the management team can make decisions effectively, efficiently, and in a timely manner.
Jon Zeiler is a partner with Crowe Horwath LLP in the Oak Brook, Ill., office. He can be reached at 630.575.4237 or email@example.com.