Financial Management-The Path to Profitability

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ASLA 2011 Annual Meeting and EXPO

SUN 82Financial Management: The Path to Profitability

Presenter

Steve L. Wintner, AIA EmeritusManagement Consulting Services

The Woodlands, TX


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© The American Society of Landscape Architects

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Learning ObjectivesUpon completion of this program, attendees will be able to:explain how to develop an annual budget and the metrics that will establish the overhead and break-even rate for every employee.explain how to develop project fee budgets based on value-added service, not just time-to-complete compensation, leading to a fee negotiating strategy that ensures a win-win outcome every time.determine how to set up, interpret, and evaluate the Profit-Loss and Balance Sheet Statement so trends can be recognized, the balance between workload and staff size can be assessed, and overhead more effectively managed and controlled.explain how eleven (11) key financial performance indicators can be calculated.


Overview

• Introduction / Framing Remarks

• Glossary of Key Accounting Terms• Annual Budget

Operating ExpensesNet Operating Revenue (N.O.R.) / Balancing the Buckets

• Top Down / Bottom Up Project Fee Budgeting

• Economic Axioms – Value-based Compensation

• Formulating Billing Rates (overhead, break-even rates)

• Profit/Loss (Income) StatementP-L Analysis: Component Elements of N.O.R.

Seven (7) Key Financial Performance Indicators

• Balance SheetBalance Sheet Analysis

Four (4) Key Financial Performance Indicators

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The Genesis of Knowledge

“Knowledge is power.- Sir Francis Bacon



“Knowledge is power.”- Sir Francis Bacon

“…is an incomplete statement.”

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Glossary of Key Accounting TermsAccounts Payable: Expenses incurred and owed to others, including consultants.Accounts Receivable: Unpaid project invoices previously sent to clients. Aging: 31 to 90+ days.Accrual Basis Accounting: Fees earned, consultant's fees and expenses obligatedand/or incurred, whether billed or not; and whether paid or not. Most firms use a modified accrual basis for their Profit-Loss (Income) Statement. This means revenue and expenses are based on invoiced amounts. Accrual accounting should never be used for determining tax liability (see Cash Basis Accounting).Annual Budget: A projection of future financial activity that includes projected revenue, consultant’s fees, reimbursable and direct project expenses, salaries and other operating expenses for 12 months (fiscal or calendar year).Backlog: The dollar amount of existing contracts not yet billed, at a given point in time (changes continually).Balance Sheet: The financial status of the firm for a specific period of time (usually the current month and year-to-date).Billing Rate: The dollar amount that your firm charges for an hour of labor spent on projects, including salary, overhead, benefits, and profit.Break-Even Rate: The cost of doing business for every dollar of project labor spent (overhead rate + benefits + salary); also known as “Billing Cost”.


Glossary of Key Accounting TermsCash Basis Accounting: Actual revenue received and actual salaries and expenses paid (a checkbook approach). This is the basis most commonly used for determining income tax liability.Current: Either an Asset or a Liability that is realized within the next 12 months. Direct Expense: Project-related expenses, not reimbursable. These would also include expenses in Lump Sum Fee basis projects, or those which are not able to be invoiced to the client, per the Contract.Direct Labor: Same as Direct Salary. Represents the salary cost of time charged to projects, whether billed or not.Indirect Expense: Overhead or non-project related operating expenses (includes Indirect Labor).Indirect Labor: Same as Indirect Salary. Represents the salary cost of time spent on non-project related activities (by all members of the firm).Liabilities: Short-term (12-months) and long-term (beyond than 12 months) debt and any other monies owed.Line of Credit: Money extended by a financial institution. Usually collateralized by the firm’s Accounts Receivables.

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Glossary of Key Accounting TermsNet Multiplier: The Revenue generated for every $ of Direct Labor.Net Profit: Profit before Distributions & Taxes. Net Operating Revenue: Revenue, including any Mark-Up invoiced, after deducting Project Consultant fees and all project related expenses owed.Overhead Rate: Total Indirect Expenses divided by Total Direct Labor.Proposals Pending: Proposals sent to potential Clients for potential projects.Reimbursable Expenses: Project-related expenses that are invoiced to the client in addition to fees. Appropriately would also include mark-up percentage on those expenses. Mark-Up becomes a part of Net Operating Revenue and adds to profit.Retained Earnings: Cumulative Profit-Loss since the inception of the firm.Retainer: Also referred to as ‘Initial Payment’, paid to firm at the outset of the project, per Contract, before work has started. Shown on Balance Sheet as a Liability for ‘Unearned Income’ and invoiced at end of project.


Preparing the Annual Budget

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Maintaining N.O.R.Balancing the Buckets


Budget Format: Revenue, Direct Labor, Indirect Expenses

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Summary (Collapsed) Budget Format


Annual Profit Plan

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Annual Profit Plan – Net Operating Revenue


Annual Profit Plan – Calculating Multipliers

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Project Fee Budgeting


Economic AxiomsIt’s unwise to pay too much, but it’s worse to pay too little. For when you pay too little, you sometimes lose everything, because what you paid for is incapable of doing what it was bought to do.The common law of business balance prohibits paying a little and getting a lot; it can’t be done. If you deal with the lowest bidder, it is wise to add something for the risk you take and if you do that you might as well pay for something better.- John Ruskin, The Price Perspective

The bitterness of poor quality lingers long after the sweetness of a cheap price is forgotten.- anonymous

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Formulating the Billing Rate


Formulating the Billing Rate

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Profit-Loss (Income) Statement


Profit-Loss (Income) Statement – Revenue, Direct Labor

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Profit-Loss (Income) Statement – Revenue Components


P-L Statement – Component of N.O.R.

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Profit-Loss (Income) Statement – Expenses & Net Profit


Profit-Loss – Key Financial Performance Indicators1. Utilization Rate

Time spend on project activities, expressed as a percent of Total Hours worked.NOT a measurement of productivity.This is not necessarily billable time. It is chargeable time, which may or may not be billable.

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Profit-Loss – Key Financial Performance Indicators

2. Overhead RateMeasurement of non-project expenses as a percentage of project labor (Direct Labor, in dollars).The overhead rate must be known to properly establish hourly billing rates.Once the overhead rate has been determined, profitability can be determined. Without an accurately determined overhead rate, profit is only an estimate, or worse, a guesstimate.



3. Break-Even RateCost of operations for every dollar of labor.This factor is essential to negotiating a fee which will include a desirable profit margin.Once this factor has been determined, a profit margin can be established and billing rates determined.

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4. Net MultiplierMeasurement of Revenue as a percentage of Direct Labor.The Net Multiplier indicates the $ Revenue earned for every $ of Direct Labor spent.



5. Aged Accounts Receivable (A/R)Represents unpaid invoices.An Aged Accounts Receivable Report indicates which invoices, and their amount, that have not been paid. Most reports will indicate the number of days since the invoice was sent.Each firm should establish, as a condition of the Contract, the number of days from the invoice date when the payment is due. Invoices that are unpaid after this period are considered outstanding or “aged.”

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6. Net Revenue Per EmployeeRepresents the Revenue potential generated for each employee.This factor is useful for determining a realistic range for Net Operating Revenue for the budget for the year.



7. Profit-to-Earnings (P/E) RatioSince the projects produce a firm’s profits, the P-E Ratio indicates a firm’s effectiveness in completing projects profitably.

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Balance Sheet - Assets


Balance Sheet – Liabilities & Stockholder Equity

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Balance Sheet – Key Financial Performance Indicators

• Solvency: The ability to pay debt.

• Liquidity: The ability to convert assets, excludingFF & E, to cash.

• Leverage: The ability to manage debt appropriately.

• Return on equity:The amount of profit produced relative to the money invested to earn it.


Balance Sheet – Key Financial Performance Indicators

SolvencyReferred to as the “Current Ratio;” the ratio between Current Assets and Current Liabilities. Lenders look for a minimum ratio of 1.5:1.Formula: Total Current Assets / Total Current Liabilities

LiquidityReferred to as the “Quick Ratio” or “Acid Test.” Lenders look for a ratio of 1:1 or better.Formula: Cash + Accts. Receivable + Work-in-Progress / Total Current Liabilities

LeverageReferred to as the “Debt-to-Equity Ratio”. Acceptable ratio: Total Liabilities should not exceed Stockholders Equity by more than 35 percent (ratio should be 1.35 or less).

Formula: Total Liabilities / Total Equity

Return on EquityReferred to as Owner’s or Shareholder’s Equity.Formula: (Net Operating Revenue – Total Expenses) / Total Equity

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Balance Sheet



“Knowledge is power.”- Sir Francis Bacon

“…is an incomplete statement...

“until it is implemented.”- Steve L. Wintner, AIA Emeritus

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Q & A


SUN 82Financial Management: The Path to Profitability

Presenter

Steve L. Wintner, AIA EmeritusManagement Consulting Services

The Woodlands, TX

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Steve L. Wintner, AIA Emeritus• Founder and principal, Management Consulting Services

• 55 years of professional experience; 26 years serving a national clientele

• Co-author, Financial Management for Design Professionals: The Path to Profitability

• Author of numerous articles on design-firm management in AIA Practice Management Digest, AIA Best Practices, andAIArchitect.

• Author of Management Tools, monologue of 12 articles on issues of professional design firm management

• Developer and workshop leader of The Path to Profitabilityworkshop for AIA national, state, and local components

• Workshop leader of Annual Budgeting for Design Firms, Profit Planning, Project Fee Budgeting, and Project Administration.

Documents

Financial Management-The Path to Profitability