The Financial Model of an Architect’s Office is a well-kept secret. I have never seen it mentioned anywhere. But there are several things that need to be in balance to get positive financial results. The resources available from the AIA are only useful if you already have an MBA-like understanding of finances.
A Financial Model entails more than “Income minus Expenses should be a positive number.” Negative numbers equal poison. You can’t survive much poison.
I have to mention Page Highfill here. He is the architect who told me about the
financial model that architects need to know about.
I think of the financial model in terms of a spreadsheet like the one above, which is really three connected spreadsheets. The key part is the Billing Overhead Factor [BOF] calculation. The BOF depends upon your Total Expense Budget. From these two pieces you can develop Targets to guide your efforts.
See the end of the article for how to get a copy of the spreadsheet.
Let me describe each part starting with the BOF.
Your Billing Overhead Factor is the one thing that summarizes everything about your firm’s finances. A low BOF means you have an efficient organization. A high BOF is a burden. It means that your inefficiency makes it hard to compete on cost. It means it will probably be hard to make a profit.
Your BOF will show you why you can’t spend money on everything you would like and why you can’t spend all the time you would like to get the work done and why you can’t charge lowball billing rates. More importantly it will show you how much you can spend, both time and money, and how much you need to charge.
The key determinant is productivity. Building your BOF is an exercise in learning how to get the balance you need for productivity.
The Financial Model is the plan. However it is a bit complicated to monitor on a regular basis. Luckily along the way you develop a ratio that is easy to monitor - your Billable Ratio.
Your Billable Ratio is simply the percent of the time you are billable. Four hours per day billable is 50% billable. 30 hours per week billable is 75% billable. How does that calculation compare with the ratio that your BOF is based on? You need to know.
As I mentioned above your Total Expenses are part of the Financial Model. Before you can complete your BOF calculation you will need to get your expenses totaled up.
It is helpful to breakdown your payroll estimate into Billable and Non-Billable amounts. Other overhead expenses are always a challenge (I find). They seem to grow constantly. It really boils down to eliminating things you can live without.
Budgeting For Expenses will show you one way to evaluate overhead expenses.
Project Expenses might be ignored. We allocated about $10/person/month to cover the incidental things that come up.
I recommend ignoring the cost of Reimbursable Expenses and Consultants since they are offset by ‘pass-through’ income. More importantly, they really don’t have anything to do with the calculation you are doing.
Finally you see targets for key income and expense categories. These are determined by all the work up till now.
I should warn you that you will never hit your targets, so don’t be too optimistic. Something always seems to happen to ruin your plan.
I have found that you are better off being slightly understaffed in order to make your targets.
There is no downside to being pessimistic about your Net Revenue target. If you are proven correct, then you are ready for it. If you are wrong about a pessimistic target, then you have a better year than you planned for.
Tweak your model until you have easy goals to meet. Plan your staffing and expenses so that you are bound to be profitable.
I have found that this exercise in building a financial model of your firm gives you a really good insight into what needs to happen.
BTW this isn’t a one and done exercise. Anything that happens to payroll (raises), staffing, or divergence from your targets is a signal that you need to update your BOF.
The workbook described here is available for purchase. The Financial Model Workbook download is a zip file containing instructions, and two versions of the workbook - Numbers, and Excel xlsx . There are versions of a budget spreadsheet for your use also.
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