How to Best Manage Your Architecture Firm’s Finances?
Well managed firm finances can be a raise to glory but if you fail at keeping them under control they quickly turn into a silent assassin. Why? Because, since as architects we don’t get much business education in school one of the common downfalls prove to be mismanaged finances.
Post-corona, the AEC industry is facing an unprecedented demand for architecture services. Therefore if there was ever a time to say that slow-paying clients are not acceptable, it is now.
What strategies do you need to consider for financial profitability? How to diversify your efforts to ensure a stable flow of income and firm growth? What tools do you need to manage your finances in the right way? What are the key most important things to think about as a business owner from a strategy and development perspective? How to price your projects accordingly?
The problem of not being paid on time proves to be a pressing issue for both: big and smaller firms. When I started working as a business consultant for Architecture firms, I started by servicing smaller firms. Almost every single client who came to me struggled with their firm’s finances. Some clients take as long as a year to pay their bills. At the same time, firms are having difficulty staffing up to meet the demands of their new clients.
The unfortunate fact is that if the firm is not big enough, it may really be affected by the irregularity of payment vs team growth.
The working capital problem is one that a lot of people in this business don’t understand. It’s a huge problem, and one that needs a lot more attention and education if AEC firms are going to deal with it.
Per Wikipedia, “Working capital is defined as current assets less current liabilities. If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit and negative working capital.” They go on to say, “A company can be endowed with assets and profitability but may fall short of liquidity if its assets cannot be readily converted into cash. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses.”
Mark Zweig, leading management and business expert in the architecture and engineering industry, founder of Zweig Group explains it in one of his articles written for their AEC firms community through the Zweig Letter.
While normally accounts receivable would be considered part of an AEC firm’s current assets, when clients take a year to pay their bills, you can hardly call it that. No bank would normally allow you to borrow on an accounts receivable-based line of credit for anything over 90 days old.
The firm will need to have enough cash to keep paying all of its people and all of its other overhead for the time it takes their clients to pay them for their work. That’s a tremendous amount of money.
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In his article Mark says:
“If you have a $20 million annual revenue firm and your operating expenses are $18 million, you need $1.5 million of liquid cash for each month of your average collection period. So a 90-day average collection period means you need $4.5 million in liquidity just to keep your doors open. If it is a year, you would need $18 million in liquidity to cover that.
If you are an owner in your firm, you don’t want to have to leave that kind of money in the till. If you are organized as an S-Corp, LLC, or other type of legal pass-through entity for tax purposes, you need to be able to allow your owners to extract enough distributions to cover your taxes. That usually means at least 35 percent to 40 percent of your profits have to go to owners, unless they want to dig into their own pockets to meet their tax obligations from the money they make on their firms. In the above example – for a $20 million revenue company with $18 million in expenses and a $2K profit, they would have to pay out roughly $800K to owners at a minimum just so they can meet their tax obligations. If their clients take 90 days on average to pay their invoices, that means they need $4.5 million in working capital and with $2 million in profit less $800K in owner distributions. That means they would have to make $2 million a year for FOUR years – paying NO bonuses to employees and paying only enough in distributions for owners to meet their tax obligations and nothing more. If clients take longer than 90 days to pay, this number goes up. That’s crazy!”
Mark’s advice to this is: “AEC firms must stop tolerating these kinds of slow-paying clients. We cannot afford to finance the other guy’s (or gal’s) business. We – as a group of companies or “industry” – are facing unprecedented demand for what we do. If there was ever a time to say that slow-paying clients are not acceptable, it is now. You cannot keep working this hard for so little payout just to fund your working capital needs.”
To unpack the operational side of this issue, I interviewed Kathy Dixon, author of “The Business of Architecture” book and a principal at Kathy Dixon Architecture. Kathy is one of the keynote speakers at Disrupt Symposium, a 5-day (1-5th May) Business of Architecture Symposium, handcrafted for architecture entrepreneurs with a sole purpose to help elevate the AEC industry with business education. Kathy will join the event with a 20-minute presentation dedicated to the topic of “How to run a financially successful architecture practice”. The event welcomes to stage top level executives, directors, partners and leaders of world’s most influential architecture firms such as: SOM, Gensler, BIG, Snohetta, Perkins & Will, UnStudio, Zaha Hadid Architects, OMA-AMO, ARUP, Safdie Architects, Woods Bagot, Amanda Levete Architects, WallaceLiu, Simone de Gale and many others.
Kathy Dixon Architects is a fast growing firm, and with that they are up against a few challenges which you may also be seeing in your practice. Implementing the appropriate policies, staff, procedures, consultant professionals, tools and software and at the correct time is paramount to running a successful practice.
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Kathy tells me that as much as there are no guarantees for success or financial profitability, there are decisions that can be made to lower the risk of failure and loss that will put you on the right path. Deciding what types of projects your firm will pursue is one crucial decision that will reflect directly on your balance sheet. Single and multi-family residential projects, though creative and fun, are not typically known to be lucrative as far as revenue. The amount of time spent is very similar to the amount of time to deliver a small commercial project, but there is a significant difference in the amount of fee and potential return. Making a decision to focus on certain building types and services will limit the percentage of revenue at the end of the year.
Similar to making strategic decisions to pursue specific project types, a laser focused decision must be made to pursue diverse opportunities. Do not dismiss varied types of business relationships like joint ventures and teaming, solely because you have not yet experienced it. Or if your prior experience with one company was not great, it does not mean that a partnership with another firm won’t be fruitful and successful. Being open to different kinds of teaming arrangements makes your firm more agile and capable of fitting into the needed slot for a particular contract. This strategy, in addition to providing services other than traditional architecture design, can be quite lucrative for your company. Services to consider providing in-house might be urban planning, interior design, civil engineering, project management, program management, owner’s representative, and construction management services.
So what tools do you have to use to manage your finances correctly?
Fortunately, there are great cloud-based tools and software available to today’s firm which can assist the small business owner to manage his/her finances. Quickbooks and Freshbooks.com are two examples. In addition to the accounting tools, your firm must have a project management tool to manage the fees by project, project phases, and services in general. Packages range from modest ones like Core BQE (formerly archioffice) and Ajera to more comprehensive ones such as Deltek VantagePoints. Tracking your hours per phase and service is the best way for an architecture firm to determine its efficiency, utilization, and profitability at the end of the year.
It takes time to complete the average project (12-18 months) and thus it takes even more time to realize results from plans implemented today. Having a management strategy for the next 2-3 months, 6-12 month, 1-2 years, and 2-5 years is ideal to determine the direction of the practice. What is your current project workload? What is the backlog? How much work do you need to keep your current staff busy? What services do you want to grow in the next couple years? Who in the firm can step into leadership roles in the next few years? Asking and answering these questions of your firm on an ongoing basis is absolutely necessary to keep the practice moving in the direction that you want it to go. Of course, be adaptable to industry, economic, and market changes. Having a plan will help to maintain the flexibility needs when unforeseen outside influences affect your business.
As the owner or principal of the firm, it is your responsibility to bring new work into the business. This is a full-time task and will take up much of your time building relationships, researching client forecasts, finding opportunities, and responding to those opportunities. You will need a team of people around you to help secure contracts while you also oversee the current work being produced by the firm. Office manager, Graphic Designer, RFP writer, Marketing Manager, and Project Architect are all positions that will assist in the client acquisition process. Directing consistent and continual marketing efforts are a necessary and major part of the Principal’s weekly and ongoing schedule.
Determining how to price your services is a skill that one acquires over time. There are very limited resources for firm owners to help with fee proposal writing with regard to percentage of fees for various project types and design phases. The sole source that Kathy discovered and recommends are Guidelines Online which provides A/E fee rules of thumb for many different project types and incorporates variations for different areas of the country. This resource can be used in addition to your own calculations for forecasting the number of hours it will take to complete each task. Comparing percentage rules of thumb based on construction cost against fully-burdened rates for staff salaries will help to put you in a competitive range for issuing a fee proposal and managing revenue for completing the project.
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If you found this article valuable, you must join us at Disrupt Symposium 1-5th May 2022. In this event we will go above and beyond firm finance and operation topics to cover all major business related issues.
Topics covered include business strategy, business development, client acquisition, financial management, sales, marketing, communications, branding, social media, public relations, the business of expertise, expert positioning, publishing online and in print, leadership, team building, recruitment, retention, and leaving a legacy behind.
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