THE INCOME STATEMENT & KEY PERFORMANCE INDICATORS FOR ENGINEERING & ARCHITECTURE FIRMS
BASIC CATERGORIES OF REVENUE AND EXPENSE
The Income Statement has only one area for revenues and four categories for
expenses. For the expenses, there is a separation between direct (those which are chargeable to direct projects) and indirect or overhead expenses. Typically, these are
categorized as either labor or non-labor expenses. As a result, the main categories for Income Statements are Revenues, Direct Expenses, Direct Labor, Indirect Expenses, and Indirect Labor. Deducting ALL expenses from revenues and the amount remaining is Operating Profit. Sometimes referred to as NOI (Net Operating Income) or EBIT (Earnings before Interest and Taxes).
See my blog on DCAA & FAR compliance with Deltek Vision:
Revenue depends on how the firm chooses to recognize revenue. It can be as simple as the sum of all invoices sent to clients where Billed = Revenue. Others may choose to have some WIP (Work in Process) recognized as well so that revenue is NOT solely dependent on billing. This too can be a simple calculation of Billed + WIP. WIP = the sum of all Unbilled Labor & Expenses at Billing Rates, but it may also have limits or other formulas using the project budgets as part of the formula. For Fixed Fee projects it can also be based upon a % complete.
See my previous blog on Revenue Generation:
Direct expenses are all expenses incurred on a project. They include both reimbursable and non-reimbursable expenses. In Deltek Vision these are known as Reimbursable (billable) or Direct (non-billable) expenses. Whether a T&M type invoice where billable
expenses are listed or simply included in a fee amount these expenses are included as part of your invoice posting in Deltek Vision.
Net Revenue is simply Revenue minus ALL direct expenses, whether billable or not.
Direct labor is the hours charged to Direct Projects times the Job Cost Rate for the
Employee. For Hourly employees it is simple math. For Salaried employees
firms do it differently. Deltek Vision calculates the annual salary divided by 2080 to calculate the Hourly Job Cost Rate. Therefore, if a salaried employee has more than 40 hours in a standard week of time on his timesheet then his Gross Labor Cost will be overstated when compared to his salary paid. Some firms choose to eliminate this variance using Deltek Vision’s utility called Adjusted Salary Job Costing. Takes a few seconds and recalculates the hours each week to the paid rate instead of the calculated Job Cost rate. Other firms choose to post this negative variance to overhead reducing their overhead by an equal amount to that which was overstated. Both options satisfy all GAAP & DCAA audit requirements.
See my previous blog on Adjusted Salary Job Costing:
Gross Margin or Profit
Gross Margin simply Net Revenue minus Direct Labor whether billable or not.
Operating Profit, EBIT or NOI
Deducting all Indirect Expense from the Gross Margin produces your firms Operating
Profit. No matter the name is the same for all firms.
Cash Basis Accounting
See my blog if you are also using Cash Basis Accounting:
10 Key Performance Indicators
The utilization rate is the percentage of hours spent on direct projects vs. the total number of hours worked. It is not a measure of productivity. A reasonable goal for the entire staff would be a utilization rate of 60 percent to 70 Percent. For the Operations, professional and technical staff a reasonable goal would be 75 percent to 90 percent. Most firms today are calculating the Utilization based on the “Standard – Benefit”. The standard is 8 hours per day for salaried personnel and the total hours on the timesheet for the hourly staff. Benefit hours are hours charged to any overhead project designated as a Benefit project. In a week with 8 hours charged to holiday
where 32 hours is direct, using this calculation the employee would have a 100%
The overhead rate is the cost of all overhead related expense (Indirect expenses, including indirect labor) expressed as a percentage of total direct labor. It’s perhaps the most critical of all the performance factors. If it is unknown or calculated incorrectly, it is impossible to accurately determine the firm’s profitability. The lower the overhead rate, the higher the profit margin. A target of 150 percent to 175 percent of total direct labor (1.5 to 1.75 x total direct labor) would be acceptable. Managing indirect expenses will reduce the overhead rate. A rate that exceeds 1.75 is usually of concern to management.
Each employee of the firm has his or her own break-even cost, which represents the actual cost of each person’s Employment. It’s equal to the overhead rate plus each person’s hourly salary, represented by the unit of 1.0. If a firm has an overhead rate
of 1.5 (150 percent) then the break-even rate for each employee is 2.5 x hourly
salary (1.0 + 1.5 = 2.5). For an employee with an hourly cost of $30, the break-even cost would be $75 per hour. To develop an hourly billing rate for each employee, divide the break-even cost by the desired profit margin. If a 20% margin is desired divide $75 by .8 (1.0 – .2) which would give a billing rate of $93.75.
Net Revenue Multiplier
The net revenue multiplier represents the actual revenue generated by the firm, expressed as a percentage (or multiple) of direct labor. If the NR multiplier is greater than the break-even rate then the firm is earning a profit. If it is less than the break-even rate then the firm is losing money.
DSO (Days Sales Outstanding)
The average age of a firm’s receivables (both billed (Aged AR) and unbilled (WIP) can be calculated. The formula is Outstanding Receivables divided by the average revenue stream. Some firms calculate their average revenue stream using the past 90 days (Gross Revenue for current & 2 prior periods divided by 90). Others use a yearly
average dividing by 365. 85 days is a standard firms should strive maintain with BOTH Billed & Unbilled Receivables (WIP) being booked and calculated. Firms who do not book WIP (Unbilled Receivables) should expect DSO on billed receivables only to be at 60 days or less. To achieve this you must bill every 30 days or sooner and collect within 30 days of your invoiced date.
EBIT as a % of Net Revenue
This metric is determined by dividing the profit known as EBIT (Earnings before Interest & Taxes) by the net revenue. It indicates a firm’s effectiveness in completing projects profitably. This is found on income statements for each indirect and the total. The EBIT as a % of NR” is a key financial metric.
Net Revenue Per Employee
The net revenue per employee is calculated by dividing the annual net operating revenue by the number of employees. It is useful in forecasting a realistic range for future annual net operating revenue.
Cash flow is a measure of how much money the firm actually has on hand at any given time to pay accounts payable: employee salaries, taxes, insurance premiums,
reimbursable expenses, consultant fees, and expenses. While a firm may appear
to be profitable on paper, cash flow can be a serious challenge for professional service firms and can adversely affect the ability of a firm to meet its financial obligations to employees, vendors, and consultants in a timely manner. A monthly cash flow report and 12-month cash flow projection can help a firm plan ahead to smooth out the swings in cash flow by accelerating collections, requesting an initial payment prior to starting a project, and carefully planning purchases of equipment and supplies.
The backlog is the unbilled dollar value of a firm’s current projects. Because monthly invoices continually reduce the firm’s backlog, it is essential to continually replace
invoiced fees with newly contracted fees. A desirable target for backlog is equal to or greater than the firm’s annual net revenue.
Aside from financing, the term burn rate is also used in project management to determine the rate at which hours (allocated to a project) are being used. To identify when work is going out of scope, or when efficiencies are being lost simply put, the burn
rate of any project is the rate at which the project budget is being burned or spent.