09
Bringing it all Together – Reporting at Practice Level
It is a key task of management to be able to gather and then successfully interpret all of the information that it has available to it. Over the years at SEH, I have continuously produced a monthly management pack of information that is easy and quick to update and – more importantly – is easy to digest. We believe that this pack now allows us to spot problems and react to them rapidly before they develop or become too threatening. The fact that we were able to survive the financial downturn of the late 2000s is at least some prima facie evidence that our approach was successful.
The process of successful financial management is somewhat like driving a car. You need to have the majority of your attention focused on the road ahead and what the other traffic (your clients and competitors) is doing. But you also need to be constantly glancing down at the dashboard to check that there are no warning lights flashing. When a light does show, you need to understand how serious the problem is – can you keep going for another few months and fix it later, or is it an urgent problem that could bring the whole practice to a sudden stop if not dealt with soon?
The previous chapters have looked at the various management tools and reports that you can use to get an idea of future fees and expenses.
From these you can produce a cash flow forecast that shows whether the financial future is likely to be a comfortable or bumpy ride.
The journey your practice is planning to take is mapped out by the annual budget. Progress is monitored on a monthly basis by comparing where you are with where you planned to be at this time. This is the satellite navigation system with which you can get back on track from wherever the practice finds itself.
The view through the windscreen of the road ahead is the captive fees forecast. As discussed in Chapter 6, that chart tends to have a familiar pattern, showing what the practice will be doing for the next month and probably for a month or two after that. The following three months after that are sketched in but the timing is subject to change. Beyond that period there may be captive fees of about 50 per cent of what may be needed, and then after that very little at all that is firmly committed. Most practices will have a forward order book profile that looks like this.
At SEH our ‘cliff edge’ tends to be six to nine months away. The trick is to ensure that it always remains that far away. If it does start to recede towards the left-hand side of the chart and become only three or four months away, then we know that we need to get busy trying to convert some of those ‘possibles’ to become ‘captives’. Larger practices may well have a ‘cliff edge’ that is 18 to 24 months away, whereas a small practice may only have 3 or 4 months of confirmed work in front of them at any given time.
Turnover Analysis
As well as ensuring that the practice is growing and making a profit, you need to maintain the balance of the expenditure profile or relative shape of the practice. The turnover analysis chart shown below illustrates this.
Turnover analysis
This chart analyses the turnover of the practice each year in terms of the percentage of the overall amount that is spent in each of the main practice areas.
The turnover analysis chart uses the same categories of costs that are used for preparing the monthly flash report shown in Chapter 2 (i.e. staff, premises and all other overheads). The column on the right-hand side of the chart shows the target benchmark performance. In this example the target profile for turnover is:
- Staff – 50 per cent
- Property – 12 per cent
- Overheads – 20 per cent.
This leaves 18 per cent as profit or funds available to contribute to future growth and the development of the practice, as shown as the top slice of the bar. This represents an aspirational performance and in truth very few architectural practices are able to achieve a profit margin anywhere close to 18 per cent. In fact, many practices operate on a wafer-thin profit margin of 5 per cent or less. This is a dangerous way to operate, because it only takes a few things to go wrong for the practice to find itself in serious difficulty, as it will not have built up the financial reserves required to ride out any crisis.
Plotting the actual performance year by year against the benchmark in the same format enables you to see very quickly if the practice is moving towards the benchmark or, if not, to identify the area of expense that seems to be ‘out of shape’.
In the example above, the practice made only a very small percentage of profit of 2 per cent in the first year. The problem is immediately apparent: far more was being spent on staff costs as a percentage than the target. Actually, the cost performance for the property and overhead categories was better than the target, but it was not enough to rescue the overall position.
Some small degree of progress is made in the right direction in years two and three but this is achieved by the further squeezing of property and overhead cost, rather than by addressing the real issue which is the proportion of total spend that is going on staff.
The situation reaches crisis point in year four. The property and other overheads are again kept well under control, but staff cost percentage increases once more and as a result almost no profit is made at all. At this level of profitability there will not be enough spare funds being generated to provide the money that will be needed to replace or upgrade computer equipment and other assets.
In the example, the crisis seems to have finally prompted the management of the practice to take some remedial action: in year five staff costs are finally reduced and a degree of profitability is restored. Further significant progress is made in year six and the practice turns in a very creditable 15 per cent profit.
It is very important to understand that these are percentages and are not absolute financial values. It is quite possible that the practice described above was enjoying rapid expansion in the years of very low profit margins. Almost all businesses find it hard to maintain their profit performance in terms of profit margin during a period of growth or contraction.
It’s easy to see how this could happen in an expanding architectural practice. It is only natural when a practice wins a large new project that one of their first actions will be the recruitment of some new staff to help deliver the work. It is unlikely that the practice would have people ready and available just in case a new project was to arrive. Most practices tend to run a bit light on staff resources, because there always seems to be just a bit more work on hand than was expected. So sometimes there can be something of a panic reaction, especially if this is a new client and the practice is understandably keen to impress. That’s fine while the new project is in its early design stages and is in a labour-intensive phase. Yet this time will pass, and people will gradually be released from the project onto other work. They may well have useful fee-earning work to do, but it may not be as profitable as the initial work on a major project. As discussed earlier in this book, fees tend to be front-loaded and the majority of the profitability on a project accrues in the early stages. In this way, additional resource costs get accidentally built into the practice, and the cost shape of the practice begins to suffer.
If nothing is changed, the cycle will repeat itself when another new project is won. Once again, after six months the practice has built in even more staff costs. This may seem to be acceptable as the practice is increasing turnover. It is only when the overall cost structure is reviewed in percentage terms, as shown in the example above, that the problem is discovered.
It is a common experience for a growing business to find that, despite a doubling of turnover, the amount of profit they have made in money terms has stayed the same or even fallen. This can be a source of great disappointment, prompting questions such as ‘Why did we bother to do all of this extra work, if we are only going to end up with the same amount of profit as we had two years ago?’
The answer, of course, is to find a way to maintain the turnover at its new increased level, but to address the cost profile issues so that a satisfactory margin of profit is made. At an increased level of turnover, if the practice can successfully reshape its resources cost profile, then it should be well placed to make a healthy profit, which will provide it with choices and opportunities.
Benchmarking
While reviewing the performance of the practice at the overall level, it interesting and informative to see how the practices of comparable size are performing. Participating in inter-firm comparison exercises is a great way to do this and the RIBA now has its own service in this area.
The survey covers all areas of practice and although financial performance is covered extensively, there are also sections on marketing, the winning of work, the use of technology and human resource issues.
Summary
- It is essential to learn how to read the signals indicated in the various reports and indicators, and avoid getting bogged down in any one particular area.
- Remember: successful financial management is like driving a car: most of your attention is focused on the road ahead (confirmed future fees income) while continuously glancing down at the fuel gauge (potential fees income), the oil pressure gauge (the cash flow forecast) and the engine warning light (the resources forecast) and also by looking in the rear-view mirror regularly and comparing the current performance to the budget and your performance in previous years.
- Keep an eye on the overall expenses profile of the practice (using the turnover analysis chart), especially in periods of rapid growth or decline.
- To avoid accidental build-up of staff numbers when you win new work, consider other forms of short-term resourcing, sometimes utilising temporary or contract staff or perhaps some form of outsourcing.
- It can be useful to participate in inter-firm comparison or benchmarking exercises such as the service offered by RIBA. This covers all areas of practice and peer comparison which can be very revealing.