Whenever the economy tanks, I get really interested in cash flow. It's a habit that I try to hang onto when things are going well, too, because you can run out of money any time. But there is something about impending doom that gets your attention. Most of the guidance you can find on cash flow is geared to 'small businesses', less than 5,000 employees! This isn't very helpful.
In a nutshell cash flow is predicting your cash-basis profit or loss. It is the nature of predictions to be wrong almost all the time. So a cash flow projection isn't reality, but you want to get close enough that there aren't any devastating surprises.
This simple spreadsheet below is my attempt to get a view of the income side of the cash flow projection. The idea is to quickly allocate your fee for a project over time so you can compare it to the other ingredient - an expense projection.
Whether you have arrived at a fee by a wild guess or a fee schedule you want some kind of corroboration.
One option, if you keep good records, is to compare this project to a similar project. Was the fee adequate on that other one? Usually the two projects are dissimilar in some way.
Another way of checking the 'rightness' of an architectural fee is to evaluate its 'rightness' when viewed as a design budget.
This option involves doing an evaluation. It is fairly easy to 'spread out' the fee over the design phases to see how adequate the fee actually is.
I don’t know what it is about accounting. It is really boring. And yet I am repeatedly drawn to the challenge of finding a system that works for architects.
This past week I revisited two services that I hadn’t looked at for over five years - LessAccounting and FreeAgent. I have already put LessAccounting aside for the time being. You would probably need a better timekeeping system than LessAccounting’s app, LessTimeSpent. And other aspects just weren’t falling into place.
FreeAgent on the other hand has me digging in.
My Interview With Business Of Architecture / Enoch Sears
A guy who knew me from my Corbu adventure mentioned me to Enoch Sears. Enoch has a website called The Business Of Architecture. Part of what Enoch offers is a podcast that interviews people in the architecture industry. He invited me to be interviewed. I said, 'Yes'. And here we are.
The interview is broken into two parts below.
During my career we saw a wide range of projects. They ranged from really small and simple to really big (for us) and complicated. On the small end of the spectrum was a two-car garage addition to the side of a house. On the opposite end of the spectrum was a new high school. I will show you how the five fee tables of a fee schedule can span that kind of range. Let's take a closer look at the five tables that make up the fee schedule.
My firm had in-house payroll for 30 years. I thought it was great. Pay period ends. The next day everyone had their paychecks by 11 AM.
It wasn't until the last recession had us on the ropes, and, simultaneously, our accounting software provider wanted $12,000 for their new program that replaced the old program that they had decided to abandon that we challenged what we were doing.
The chicken or the egg
If you specialize in one project type, your past experiences give you a solid basis for determining fees. But what do you do until you have past experiences to draw on? When you don't have a comparable project to use for gauging the right fee, a fee schedule gives you a way to arrive at an appropriate fee for your project.
Even where you have a similar project, the size or some other aspect of the new project might be significantly different.
During my career we used a true accounting package designed for architects. You would think that everything worked great. You would be wrong. When it came to checking on the status of a project's budget, you rarely got an answer in the time frame that you were expecting.
Why wasn't a Project Status readily available?
The point is that getting a timely project status was a lot of work to keep up with.
I am happy to report that bookkeeping solutions don't require all of that.
Here's all you do...
Small firms don’t need accounting.
Your accountant doesn’t agree with me.
He’s wrong unless your firm has over 20 members.
The problem with accounting is that it requires brain-surgery-precision for a task that doesn’t much matter. When you stop to think about the time, effort, and aggravation that accounting requires; and what benefit you receive in return; something is fundamentally wrong. Basically you can’t afford to do accounting until you are large enough and complex enough to afford a bookkeeping employee.
I know this because my six-person firm used accounting for most of our existence and got almost no benefit from the tens of thousands of dollars per year that we spent on accounting. Why did we do it?
Ignorance. I thought I had to. I mistook AIA publications as applying to me. They don't. They apply to much larger firms than I ever had.
About 93% of architectural firms are smaller than 20 people. They can't afford accounting. They can only afford bookkeeping.
So what is the difference?
Architecture is not known, at least to those involved, as the most profitable of businesses. Salaries aren't commensurate with responsibility. We all need to work on this. Here's my first shot.
#1 ’PLANNED’ LOSES
The number one way to lose money, or at least limit your profitability, is to inadvertently plan for that outcome. (See Architectural Economics.) Many firms ignore the facts of their own operation and use industry rules of thumb instead. Know your costs and ratios; and run your firm based on facts.
Over the past year I have spent a lot of time looking into how architects do bookkeeping. My focus was on small firms of less than 15 people. I have interviewed about 75 firms and received almost 1500 survey responses.
For most of my career, my firm was seven people or smaller. For about 20 years we used Deltek Advantage and liked it. It is only in hindsight that I realized what gross overkill that software was. That is the problem that everyone in the small firm category has:
Finding a bookkeeping solution that doesn't cost too much money and TIME.
After a year I know that solution does not exist. I continue to look for programs that could be the solution - even if it means "tricking" them into being what is needed. Along the way I have learned a lot about what small firm architects use and how things could be better, even if perfection remains elusive.
These six articles describe what I have discovered.
Maybe paying your bills is supposed to be painful. If you subscribe to that way of thinking, then by all means soldier on. If you don’t subscribe, but are using a process that involves a printer, I have good news.
The Internet is here to help you.
First, let’s recap the old school process. This isn’t exactly what you are doing (because I don’t know anyone at NSA), but it is what I/we did for 25 years. It looks like this.
Profit Planning From All Sides
Profit planning wasn’t a concept I was familiar with. I distinctly remember our first profit and not knowing what to do with it. I didn't have a plan. I didn't even know I needed one. That’s probably one of the best problems to have. I don’t remember what I decided to do, but I know that was the start of many efforts to come to grips with profit planning in case the miracle happened again. I can’t claim to be an expert on the topic of ’Profit Planning’, but here are my thoughts.
Profit is not a dirty word
Everyone loves what profits do. Profit provides bonuses, improvements of all types, and the ability to grow. Let me explain what I mean by profit. The simplest way to describe it is that profit is what you pay taxes on – actually it is what is left after you pay all your expenses. In the normal course of things, you won’t find out if you had a profit until March when your accountant finishes your tax return. Profit planning requires you to be more proactive than that.
For instance you might want to pay a bonus before Christmas – the traditional bonus-giving time. We did. We could never get used to giving bonuses any other time than mid-December. So before Profit Planning took hold, we paid (modest) bonuses at Christmas based on feel and available cash. An ’informed’ decision would have been a ’different’ decision about the size of bonuses.
Our third (or fourth) accountant offered to review our books in early December so we could be more accurate and better informed about profit planning. That’s actually a good idea, but we only took advantage of the offer (and paid the cost) when we were pretty sure there was profit that needed planning. If we thought we we going to have a loss, it wasn’t because we were trying to have a loss. Besides no amount of planning would turn things around in 30 days – we would have already done that if we could.
So the first tactic for Profit Planning is predicting your profit for the year by getting your accountant to review your books and tell you where you stand. Depending on your bookkeeping system, this might be pretty easy. In any event you will be able to make a better decision about bonuses and other year-end issues.
If you start this type of profit planning around Thanksgiving, there will be another month or so for which you will have to estimate your income and expenses. We always assumed that December would be a break-even (or worse) month because of time off around the holidays and clients getting distracted with the season’s festivities.
I recommend that you take your accountant’s advice with a pinch of salt. There is a difference between accounting advice and business advice. You may have to filter your accountant’s advice by your feel for internal and external ramifications. There were plenty of recommendations I wasn’t willing to follow to save $200. You decide. You need to KNOW the numbers, but you may not want to LIVE by the numbers.
We eventually had software that gave us a good feel for where our profit/loss stood. I never felt the need to get down to the decimal point with this type of projection – a few hundred dollars either way was good enough. So this is the second way to go if you have the in-house tool to make a decent year-end projection.
I plan to include that functionality in MyCorbu eventually.
The main reason to go through all this is to determine bonuses and other uses of profit. Our situation, which I think is similar for most firms, was that we created a tax liability if money remained in the firm past year-end. Get your accountant to explain how you will be impacted so you have a guide to go back to each year. Our goal was to use up all profit by year end so that there was very little tax due. An unfortunate consequence of using up all your profit is that you will very likely be short of cash for the first few months of the new year. We made every effort to avoid using our bank for a working capital loan. Often times I loaned my bonus back to the firm to avoid a bank loan.
The key issue is that knowing the facts beforehand is much better than finding out the facts afterwards. Mark your calendar to start working on this in early November.
Uses Of Profit
So what is profit used for besides bonuses? This is the way that I think about it, and what we used profit for.
So if you have decided on bonuses, a new plotter, and a marketing initiative, you have probably just decided on how to allocate your profit. In fact my experience is that trying to allocate profit by some formula never seems to work out. Instead, if you give some thought to what you would do with a profit of $xx,xxx, this always seems to ‘allocate’ the profit. It also gives you a target to shoot for. Consider turning the process around, and decide what you would like to do, and how much profit that will take. Put numbers on each item, add them up, and you have your profit target – or at least your first stab at a target.
If you don’t go through this exercise, you don’t really have a way to determine what your hourly rates should be. If you aren’t charging enough to give bonuses, then you can’t give bonuses without going broke. (I described how to go about this in this post.) Profit gets factored into hourly rates, design budgets – make it conscious.
Markup In Profit Planning
To move beyond using an arbitrary percentage markup, plan how much profit you would like by budgeting amounts for your profit allocation. Here’s an example:
For over 20 years I had the benefit of having project profitability calculated for me by our (pricey) accounting software. You could choose from two methods. Method 1 was automatic (Yea!). Method 2 required periodic input (Boo!).
Method 1 was to let the software figure out overhead allocation each month. Completely automatic. Check the box and forget it. The downside was that the results often loaded up a project with an excessive overhead allocation. This might be due to a large annual expense falling due that month, say professional liability insurance. Method 1 was fully automatic – and useless.
Method 2 was to input an overhead allocation factor. This factor was used to allocate overhead per hour of time charged to the project. This method gave consistent results and they were accurate as long as your overhead factor was realistic. We knew how to calculate a realistic overhead factor, and you can see how here.
You have probably heard it before, and it is true. You need to fill out, and submit, time sheets daily. Why? I suspect that you know, but I'll recap for you.
There are probably thousands of ways to estimate design fees. My method has evolved over 30 years into this approach that I am sharing with you.
Estimating design fees is part science and part art (OK...it’s math and guessing). The approach that I use is dictated by the size/complexity of the project, who the competition is, and who the client is.
Before we get into the nuts and bolts, let's dispense with 'competition' and 'client' considerations. These two issues affect what you do about the number that you have arrived at as 'the fee'.
Are you spending too much time on accounting?
One of the late realizations that I had after 20 years of using a powerful accounting program is that it was costing much more per year than it should. It wasn't the $1,000 per year subscription that cost too much; it was the time required to USE the accounting program. A true accounting program, like we were using, is very fussy. If it were a person, it would be considered “high maintenance”. In our case, the time spent on accounting was time that could have been spent on billable tasks. We could have easily afforded to farm out every accounting chore for what we were “spending” in lost opportunity.
Here is how I look at time allocation for accounting now.
My first survey of architectural accounting methods collected 400 responses. These responses form the basis for this update. That first survey is effectively closed. I started to notice that I was asking different questions when I interviewed someone. So I cloned the first survey and deleted the questions that weren’t helping to understand the methods being used. Then I added a few new questions. Survey 2 is two questions shorter, but offers more opportunities to comment. I plan to publish the results of Survey 2 when the number of participants are similar to the first survey. But here’s what I have learned so far.
The first time we had a profit, we didn't find out until March when our accountant finished our tax return. We paid (modest) bonuses at Christmas based on feel and available cash on hand. An ’informed’ decision would have been a ’different’ decision.
Of course our accountant offered to review our books in early December so we could be more accurate and better informed. That's actually a good idea, but we only took advantage of the offer (and paid the cost) when we were pretty sure there was profit that needed planning. If we thought we we going to have a loss it wasn't because we were trying to have a loss, and no amount of planning would turn things around in 30 days - we would have already done what we could.
I distinctly remember our first profit and not knowing what to do with it. I didn't have a plan. I didn't even know I needed one. That’s probably one of the best problems to have. I don’t remember what I decided to do, but I know that was the start of many efforts to come up with a plan we could use in the future. I can’t claim to be an expert on the topic of ’profit’, but here are my thoughts.
What is profit used for? This is what we have done.
I have never had a perfect method for setting aside the money we owe consultants. When times are good and cash flow is good - no problem. Other times, you can find yourself in an unexpected hole with no simple way to get out.
About five years after I started my firm, our work completely dried up. We were down to just two of us and a major debt we owed our consultants. Ultimately, I talked to each one and told them of my problem (theirs too). I asked for time and promised to make some small payment every month with the full intention to pay off everything that I owed.
During this time, in order to follow thru, my take-home pay was about $10,000 a year. You want to steer clear of this pitfall. How?
Fetching Coffee For Architects VS Accounting For Architects
I was part of a two-man firm early in my career. Our office was across the street from a convenience store, which was where we obtained our caffeine (long story). I hated going over there. My senior partner didn't mind. He started the firm, and when I came on board, bookkeeping got more complicated - his checkbook no longer sufficed. He hated the idea of the more complicated bookkeeping. We made a pact: he would get coffee and I would figure out the bookkeeping.
I found a book published by the AIA, Standardized Accounting For Architects. My copy was still around up until recently. I couldn't find it when I was researching this article. I did find that you can get a used copy of it from Amazon for $240. I will have to look harder for my copy.
Standardized Accounting For Architects was and is the bible. Every accounting software system I have ever seen works basically the same way as the paper journals worked back in the day. Except easier and faster. But you can see what I mean because the AIA has a PDF available of later version that covers all the same territory, plus a discussion of computerization. Follow this link to get your own copy of Standardized Accounting For Architects.
orig post date OCT 2012
The economics of an architect's office are fairly simple. Like every other business you need more money coming in than going out. Here's how you can tell if that is going to happen.
Add up the money you are paying per month to actually produce the work that you are getting paid for. This will be primarily salaries, but more particularly the portion of the salary paying for productive work as opposed to office tasks.
Now add up all the money you are spending per month to run the office, everything, project-related expences included.
Divide the total expense by the project expense. You want the resulting number to be about 3. The lower the number the more profitable you will be. The higher the number the less profitable.
What this is telling you is how much you have to charge for each hour you work on a project to cover all your expenses. The higher the number you got, the more you have to charge. At some point no one will pay what you need to charge.
This is simple math and there is no way around it.
Let's say you want to make $100,000 a year (about $50 an hour). If the number you calculated is 4, then you have to bill out at $200/hr. If you calculated a 2, then you have to bill at $100 an hour.
If market rates in your area are $150/hr, there is a real problem with having calculated a 4. On the other hand if you calculated a 2, you can charge less than your colleagues and get more work. Or you can charge the market rate and put some money away for a rainy day, replacing equipment, or bonuses.
How do you reduce the number you calculated? Here are the things you can do:
Keep in mind that this discussion about profitability depends upon keeping the pipeline full of work and being effective in the execution of your work. Rework and poor procedures will undermine the economics of any organization.
The Article How Much Are You Worth An Hour? takes this description of finances a little farther.
If you are keeping your billable time in a spreadsheet, or, god forbid, a paper form; I found a really nice alternative, OfficeTime
Although there is a one-time cost of $47 for a Mac or Windows desktop version, you will certainly make that up by capturing all your time more easily. This is especially true if you also use the $8 iOS app so you can log your billable time anywhere.
The iOS apps synch with the desktop app by bluetooth. Once you turn it on, it just happens when the apps and desktop versions are open and nearby. I use an iPhone, iPad and the desktop and there has never been a hiccup.
The app is clean and simple with enough tools to do what you need by using the Timesheet, Project, Categories and Reports screens.
The main data entry is by adding or editing a session or expense. A Session is a work session in which you select the project and record the date, start time, time duration of the work session, and the category you want to assign the time to. If needed the session can be resumed later in the day rather than have two similar entries. The app’s settings let you use the last session’s info to avoid repetitive data entry. You can also add a note to each entry to describe the work you did.
OfficeTime works perfectly for me. I have been using a time-keeping system that is part of the accounting system that I subscribe to. I was in the market for a cheaper solution. I found a free accounting system, Wave; but there is no time-keeping and the invoicing is clumsy. That's where OfficeTime comes in. For a one-time charge that is a 75% reduction in my annual cost, I will have my needs covered. And no monthly fee. I think that for small design teams OfficeTime is a home run. Try it out, there is a 21 day trial of the complete desktop version and free, but limited, iOS apps. Constant logging of time is the only way to go. OfficeTime makes it easy.