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Entrepreneur Architect Academy 007.2 | How To Become Become The The Richest Architect You Know (Part 2 of 3)
Warning! We’re learning how to get rich (slowly) here. If you’re not interested in learning how to make money as an architect, carry on with your daily grind. For the rest of you… pay attention. We’re going to get deep into the numbers now. now. This is Part 2 of a 3 part guest post by Steven Burns, FAIA, the Director of Product Strategy and Innovations at BQE Software. Steve is the creator of ArchiOffice of ArchiOffice® ® the leading office, project management and time tracking software used in more than 1,000 small and mid-sized architectural firms. In the 14 years Steve managed Burns + Beyerl rchitects, the the firm he co-founded co-founded in 1993, 1993, the f irm’s irm’s earnings earnings gr ew at an average an average rate of 24% per 24% per year (wouldn’t that be nice?). Please visit Steve at Linkedin Linkedin and and Twitter , or check out his Blog Blog and and thank him for sharing with us at Entrepreneur Architect. – Mark
(This post contains spreadsheets, which may not view properly on some devices. You may download a PDF version of this post here.) here. )
Financial Management for the Small Architectural Firm:
Terminology and Examples 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.
(You may download a PDF version of this post here.)
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 Postage/Shipping
$12,500 $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 TOTAL EXPENSES
PROFIT GOAL
NET REVENUE GOAL
$116,667 $416,667
(20% x Total Expenses)
$83,333 $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. I use ArchiOffice to help manage project finances. Among other things, It’s able to monitor your staff’s efficiency daily, weekly and annually. You can set targets for them and know if the Efficiency Ratio you are using is realistic. Understand that low efficiency ratio equals low revenue potential and a high efficiency ratio equals high revenue potential. So let’s modify the sample profit plan above by making adjustments to acknowledge our estimated efficiency ratio: (You may download a PDF version of this post here.)
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)
Payroll Taxes and Benefits Office Expenses
$30,000
$116,667
TOTAL INDIRECT EXPENSES TOTAL DIRECT SALARES + INDIRET EXPENSES PROFIT GOAL
$94,500
$241,167
$416,667
(25% x Total Expenses)
NET REVENUE GOAL
$83,333 $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: (You may download a PDF version of this post here.)
COST RATE AND IDEAL BILL RATE Project Architect Principal 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
$126,000
$92,500
$45,300
2,080
2,080
2,080
Net Cost/Year Gross Hours/Year
Vacation
(120)
(80)
(80)
(80)
(80)
(80)
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
Holiday/Personal Leave Net Hours Worked/Year
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. (You may download a PDF version of this post here.)
Potential Realizable Income Principa
Project Intern Intern
l
Arch.
1
2
1,880
1,920
1,920
1,920
Actual Efficiency Rate
50%
75%
90%
90%
Billing Rate
$200
$125
$75
$75
Net Hours Worked/Year
Realizable Income
$188,000
Total
$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. *** photo credit: jirotrom via photopin cc S 0
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Written by Mark R. LePage · Categorized: Academy Blog Series, Business · Tagged: Billing Rates for Architects, Direct Salary Expense, Efficiency Ratio,
financial management, Profit Plan for Architects
Comments Jerome says February 19, 2013 at 10:21 am Thank you for sharing this information. It similar to the information in the Architect’s Handbook of Professional Practice but the author explains the method very well. Have do questions. How do you apply this method if you are sole proprietorship and how do you determine Overate? I have seen other methods to determine billable rate use overhead rate. Reply
Steven Burns, FAIA says February 19, 2013 at 6:54 pm Jerome, The AIA’s Handbook of Professional Practice is a great resource that is often overlooked and in desperate need of updating. I’m currently working with the AIA Small Firm Roundtable on a project to create a Small Firm Toolkit which would be the go-to source for small and emerging firms. Not as overwhelming as the Handbook and also built for a new generation. As to your question about overhead rate for a sole proprietorship. The basic concept isn’t any different than if you have 1, 3, 5 or 25 employees, so I would continue to do the spreadsheet but adapt it for just the one employee (you). You are correct, there are various methods used for calculating an employees billing rate. I gave one good example. Many firms simply take the firms’ planned net multiplier (overhead rate) and multiply that by the employee salary rate. That
may be fine in most situations but it could also depend on the realization (efficiency) of the employee. As a sole proprietor, you’ll probably see a very low efficiency rate. But there are other non-typical factors to a sole proprietor. Overhead costs tend to be very low. For example, there may not be any rent if you’re using your home as the office. And the hours you spend/week may be significantly different than if you had a partner or staff. You could spend more or less hours depending on your lifestyle choice. Reply
Mark says February 19, 2013 at 8:57 pm Thanks for following up Steve. So much information here. Thanks again. Reply
nc says February 26, 2013 at 1:26 am All these should be taught at 1st year of architecture school. Architects should also get involve in small construction or properties flipping projects as these will sharpen the real world business skill even faster. After doing a few, one might not even want to be an architect for hire anymore; instead you just want to do your own project as a builder. Reply
christian fekete says February 26, 2013 at 2:58 pm
Great beginnings, will look for the follow up at once. Thank you Question: you mention ArchiOffice in your post. I use quickbooks and I am getting pretty good with it although improvements can be made (for me) with cashflow projection. Any comments? Reply
christian fekete says February 26, 2013 at 4:50 pm Steve; Again, thx for this info, really appreciate it. I am going through the efficiency ratio but the profit goal jumped from 20 to 25%. is this correct and what would be the reason for the change? Reply
Alex Gore says July 17, 2013 at 9:03 pm Great article! The way you lay out cost, expense, and billing rates is so honest it is refreshing. Reply
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