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How do you make sure your projects run smoothly while still tracking your profitability and revenue balance? How do you measure your financial health?
In this article, we will look at the 10 Key Financial Performance indicators you can follow to run a successful firm.
We’ll explain the basic concepts of financial accounting to improve your decision-making process. Along with how to measure your financial performance and make better billing decisions.
What are Key Performance Indicators?
Financial key performance indicators are the metrics you will track to improve your firm's overall financial health.
These metrics will help you:
- Monitor and understand your firm’s performance
- Establish your billing
- Set your goals for your teams and team members
- Contribute to your overall strategic objectives.
Your KPIs (key performance indicators) are the most critical metrics to ensure that you can accomplish your business goals.
Here are the 10 financial performance indicators that provide a snapshot of your firm’s financial performance at any given moment:
- Utilization Rate
- Overhead Rate
- Break-Even Rate
- Net Multiplier
- Aged Average Accounts Received
- P/E Ratio
- Net Revenue Per Employee
- Cash Flow
- Pending Proposals
- Backlog Volume
In this article, we’ll look at each Key Performance Indicator and the formulas to calculate them.
1 - Utilization Rate
Utilization Rate Formula
Utilization Rate = Total Billable Hours (hours worked on projects)/Total Hours worked × 100
Your utilization rate is the amount of an employee’s available hours used for billable projects. It’s the best indicator that your teams are using their time well.
The rate is measured in hours and expressed as a percentage. This metric helps your company understand if it is billing enough to cover its cost plus overhead.
Keep in mind that it doesn’t measure your billable time VS non-billable time hours worked, and it doesn’t measure productivity. But maintaining an optimal utilization rate will impact profitability and efficiency.
Utilization Rate Target
Aim for a utilization rate like this:
- All staff: 60-65% ratio
- Technical and professions staff: 75-85% ratio
- Principal: 40% - 50% (lower in firms over 10.)
When it comes to Utilization Rate, the higher might not be always the better. If your utilization rate is too high, it might mean that important non-billable work is not getting done.
If your utilization rate goes over 85%, your employees are most likely burned out from overwork. So it’s important to strike the right balance between non-billable and billable work.
2 - Overhead Multiplier
Overhead Multiplier Formula
Overhead Multiplier = Total Overhead Cost/Total Direct Labor Cost
Your overhead multiplier is the ratio between your total indirect expenses and total direct labor cost.
The total overhead cost should include:
- Overhead labor cost: Annual cost of employee compensation that cannot be billed directly to projects, such as admin or marketing staff etc.
- Overhead expenses: Annual cost of expenses that cannot be reimbursed from projects, such as employee fringe benefits, rent, utilities, software and marketing expenses etc.
If the overhead isn’t known, there is no way of determining the profitability of your firm.
You can use our architect hourly billing rate calculator to calculate your overhead multiplier and subsequently determine your billing rate.
Overhead Multiplier Target
The lower the overhead multiplier, the higher the profit margin of your architecture firm. Most firms aim for a target overhead rate of 1.5 to 1.75 (150-175%) of total direct labor.
The overhead multiplier can be lowered by managing indirect expenses. Any rate over 175% is a cause for concern, and corrective action has to be taken.
How Monograph Uses Overhead Multiplier
Inside Monograph, you can input your overhead multiplier and any additional monthly overhead amount inside the Organization tab under Settings.
We use these input to provide an accurate Planned Profit Report for you month after month.
3 - Break-Even Rate
Break-Even Rate Formula
Break-Even Rate = Overhead Rate + 1.0 (which represents unit cost of compensation)
You may have heard about break-even points before.
In production terms, this is the point where your total revenue is equal to your total cost. For architects, the break-even rate is similar but tied to your direct labor.
Your break-even rate looks at the total cost of doing business for every dollar spent on direct labor - your employee compensation.
Your break-even rate is the overhead rate plus the unit cost of an hour’s salary. It helps you determine how much it costs to run a business.
For example, if your firm has an overhead rate of 1.6 (total direct labor), $1.60 is spent on indirect expenses for every $1.00 spent on salaries.
Your firm has to charge at least $2.60 for every dollar spent on salaries to break even if you take the calculation above into account.
Break-Even Rate Target
Aim a break-even rate of 2.5 to 2.8.
You can use this formula to determine how much you should bill for every dollar spent on salaries.
In practical terms, if your team member earns $80,000 per year, they earn $38.46 per hour. If your overhead rate is 1.6, the hourly break-even cost is $99.99 ($38.46 x 1.6 + $38.46). You should aim for a 2.5 or 2.75 ratio of direct labor based on the figures above.
4 - Net Multiplier
Net Multiplier Formula
Net Multiplier = Net Operating Revenue/Direct Labor
The net multiplier represents the actual revenue generated by the architecture firm. If the net multiplier is greater than the break-even rate, your firm is earning a profit.
If it is less, your firm is losing money.
The net multiplier is the ratio of the net operating revenue to total direct labor.
If you think of direct labor as an investment, your net multiplier measures your return on investment.
The net multiplier can’t be used for settling billing rates.
It measures actual performance and answers how much money you earn for every dollar spent on direct labor. In simple terms, it measures results, not costs.
You can use this formula to determine whether you are making enough money to cover your costs. If you aren’t, you can adjust your billing to cover costs and become profitable.
Net Multiplier Target
Your direct labor should be about 30% of your net operating revenue and net multiplier in the 2.75 and 3.25 range.
5 - Aged Average Accounts Receivable
Aged Average Accounts Receivable Formula
Aged Average Accounts Receivable = Annual Average Accounts Receivable/(Net Operating Revenue/365 days)
What is Aged Average Accounts Receivable?
You can calculate your annual accounts receivable by adding up the value of your accounts receivable as it stands at the end of each month. Then divide the total amount by 12.
This allows you to see how many days (on average) it takes for you to receive payment from the invoice date.
For example, you have an average annual account receivable of $200,000 per month. If your annual net operating revenue is $1,500,000, then aged accounts receivable is at 48.66 days.
You can use this formula to improve your debt collection efforts.
If clients are taking too long to pay you, you can change payment terms to reduce your aged average account receivable.
Aged Average Accounts Receivable Target
Always aim for an average time interval of 45 to 60 days to avoid running into cash flow problems.
6 - Profit-to-Earnings P/E Ratio
P/E Ratio Formula
P/E Ratio = Profit Before Distributions and Taxes/Net Operating Revenue
Your P/E or Profit-to-Earnings Ratio is determined by dividing the profit before distribution and taxes by the net operating revenue.
It indicates the effectiveness of your firm in completing projects profitably.
Profit is what remains after all expenses are accounted for before non-salary distributions are made and before income taxes.
You can use this ratio to determine whether or not your projects are profitable. If not, you may want to change your billing rates.
The higher the number, the more profitable your firm is.
7 - Net Revenue Per Employee
Net Revenue Per Employee Formula
Net Revenue Per Employee = Annual Net Operating Revenue/Number of Employees
Net Revenue per employee is a helpful gauge to check whether or not the net operating revenue for the next year is realistic.
This shows you how much money each architect is bringing in.
You can use this to determine salaries and your annual financial goal. It’s a valuable performance management tool for team members.
There is no target for this ratio, but the higher the number, the better.
It should be checked semi-annually, because it’s a good indication that your firm may run into difficulties.
8 - Cash Flow
Cash Flow Calculating Formula
Cash Flow = Operating Income + Depreciation - Taxes + Change in Working Capital
Cash flow measures how much your firm has on hand at any given moment. Your cash flow is essential for meeting your financial obligations to employees and vendors.
A monthly cash flow report and annual cash flow report can help you smooth out the swings in cash flow.
A line of credit may also be helpful to bridge gaps, but over-dependence on a line of credit can mask financial problems.
9 - Pending Proposals
Proposals are either prospects and suspects.
- A prospect is a client that you have a good chance of signing.
- A suspect is someone you’ve pitched to, but you aren’t sure if you’ll sign them.
These amounts should be compared to your firm’s budgeted annual net operating revenue.
Your total dollar amount of prospects and suspects should be 2.5 - 3 X net operating revenue.
- Prospects should be equal to net operating revenue
- Suspects can be 1.5-2X net operating revenue.
You can use this formula to see if you need to improve your marketing effort and bring on more accounts in order to keep liquid.
10 - Backlog Volume
The backlog volume is the unbilled dollar value of your firm’s current fee contracts.
Your backlog volume should be equal to or more significant than your firm’s budgeted annual net operating revenue.
You can use this number to determine if you are on track to cover all your bills this year.
When Should You Track These KPIs?
Some metrics must be calculated monthly and others semi-annually.
Cash flow should be monitored monthly to ensure you can meet your monthly objections. For example, paying salaries and rent.
Others can be tracked semi-annual, like the metrics that track whether you’ll hit your annual revenue goals.
Now It’s Your Turn!
Using these 10 Key Financial Performance Indicators, you can ensure that your architecture firm will remain profitable.
Which KPI do you already track in your firm?
Which one will you start tracking today?
Either way, let us know in the comments below.
If you want to make better decisions to increase your profitability, get started with Monograph today.