10 financial metrics every A&E firm should track
When it comes to KPIs, conventional wisdom suggests that bigger numbers are better. While that’s generally true, it’s also not quite that simple. It’s important to understand the nuances behind the numbers and how to use them to your advantage.
One size doesn’t fit all when it comes to KPIs — or architecture and engineering (A&E) firms. Make sure to track and evaluate metrics in a way that’s relevant to your firm’s size, growth stage and market.
Remember: Indicators work best when evaluated together. You wouldn’t drive a car using only the gas gauge or the speedometer — so important business decisions shouldn’t ride on one metric alone.
Use these 10 metrics to understand the financial health of your A&E firm:
1. Overhead rate
Overhead rate may be the most revealing measure of an A&E firm’s profitability. The overhead rate calculates the total of indirect (non-project-related) expenses as a percentage of total direct labor costs.
Overhead rates that are 150% to 175% of direct labor are considered within the industry norm. Lower overhead rates indicate higher overall profitability.
2. Breakeven rate
The breakeven rate is your overhead rate plus 100%. So, if you have an overhead rate of 150%, your breakeven rate would be 250%. You would need gross revenue above 250% to start earning a profit.
You can apply the breakeven rate to your firm’s total labor costs or the salaries of individual employees. For example, to offset a salary of $75,000 you would need gross revenue of $187,500.
3. Revenue per employee
To calculate revenue per employee, divide the year’s total revenue by your headcount. This metric quantifies productivity overall and can help you make decisions about hiring, marketing investments and pricing adjustments.
4. Employee utilization
Employee utilization is typically reported as a percentage. Divide the firm’s total billable hours by the total available work hours. Usually, the higher the employee utilization rate the better, but there could be strategic reasons not to max it out. For example, you might want to protect some bench strength to capture a must-win contract. Or you could invest in strategic overhead work that will give your firm a future market advantage.
5. Backlog
Backlog, or revenue backlog, represents the unbilled value of your existing contracts. It can be expressed as a total dollar amount, in months or as a dollar figure per employee.
Adjust your backlog metric after every invoicing cycle (which reduces or draws down the backlog) and after every new contract is booked (which adds to the backlog). The backlog target for healthy A&E firms is 100% of your total operating costs or greater.
6. Gross profit
Gross profit is your annual revenue minus the cost to generate that revenue.
You can adjust how much you invest in operating costs, equipment purchases, business development and other routine expenses to influence gross profit.
7. Gross margin
To calculate your gross margin, divide gross profit by total sales. Again, a higher percentage is typically considered better, but by itself, gross margin may not tell the whole story. Strategic short-term investments in wages or overhead could temporarily drive down gross margin down while setting you up for future success.
8. Net multiplier for engineering firms
Net multiplier is the ratio of net revenue to direct labor expense (dollars in versus dollars out).
Generally, a higher net multiplier means the firm is more profitable, but there is a competitive element to consider as well. When you price a must-win project, you could temporarily reduce your multiplier to edge out a competitor or to build your firm’s resume in a strategic market. The typical multiplier for engineering firms is around 2.75.
9. Proposals pending
Proposals pending is the ratio of expected new work compared to your budgeted net operating revenue for the year. Your business development team should track the dollar value of proposals that are out to “prospects” (where you have a 50% chance or better of winning) and to “suspects” (where you have less than a 50% chance of winning).
Ideally, prospects should be at least equal to net operating revenue and suspects should run around 1.5 to 2 times net operating revenue, for a proposals pending total of 2.5 to 3 times your annual net operating revenue.
10. Days cash on hand
To calculate days cash on hand, take your operating expenses for the year and divide them by 365. That’s your “burn rate” per day. Then, divide your total cash on hand by the burn rate to determine how long your firm could withstand an unforeseen revenue disruption.
Find the sweet spot that’s right for your business. Keep in mind: Having a high number of days cash on hand could mean you’re not investing the right amount of cash back into the firm.
How Wipfli can help
Which metrics and targets are right for your firm? We can help you find the right KPIs to grow with. With deep experience in A&E, our financial analysis and planning professionals can help you create KPIs around your long-term goals. With the right information at your fingertips, you can make more profitable and confident decisions every day. Contact us today to get started.
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