Business owners can learn a lot about their companies by using key performance indicators, or KPIs. These data points provide insight into the profitability of a company and give owners an early indication of potential issues.
Architectural business consultant Lucas Gray of Charette Venture Group recommends three KPIs to help firms measure their profitability: break-even point, utilization rate, and billable ratio.
1. Break-even point
A company’s break-even point is the minimum amount of revenue needed to cover business expenses. For architects and other design firms, the break-even point is ideally expressed as an hourly rate to help guide you when you’re setting your billing rates.
The break-even rate is calculated by taking total operating expenses divided by direct labor expenses. Where direct labor is the percentage of salaries that are spent on billable work (rather than overhead time).
Here’s the formula to calculate the break-even point:
Break-even Point = Operating Expenses ÷ Direct Labor Expenses
For example, if a sole practitioner pays themself a salary of $100,000 and spends 75% of his or her time on billable work and 25% on administrative and marketing tasks. The direct labor cost is $75,000.
Let’s say the total cost of all business expenses is $150,000 (including salary, benefits, licenses, rent, insurance, etc.). Divide $150,000/$75,000 to get a break-even point of 2.
This means in order to break even, the firm needs to bill their clients 2x their hourly cost rate.
Hourly cost rate is calculated as total salary divided by annual hours worked. If a worker works full time (40 hours a week), that would be $100,000/2080, which is $48.07.
The break-even rate needs to be twice this amount, so approximately $100 an hour. This is the minimum the firm needs to charge to cover its expenses. Profit is then added to this rate to determine the appropriate billing rate for that employee.
2. Utilization rate
Utilization rate is a measure of the percentage of hours spent on billable projects versus overhead or administrative work. Depending on their role in the company, workers have a varying amount of time spent on business admin, including marketing, bookkeeping, professional development, finances, IT, etc.
Some roles are completely administrative, while others split their time. Because of this, it’s beneficial to look at the overall utilization rate for the company, as opposed to each worker.
Here’s the formula to calculate the utilization rate:
Utilization rate = Billable Hours ÷ Total Hours Worked
For example, let’s look at a two-person firm that includes a designer and an office manager. In a month, the designer worked a total of 200 hours with 160 hours of billable work. The office manager focused solely on admin tasks, working a total of 80 hours.
To get the utilization rate, take the billable hours (160) and divide by the total hours worked (280). The rate in this example is 57%.
Firms should target a utilization rate of 65% according to Gray. This means that approximately two-thirds of the total time spent should be billable. Typically, design staff would be in the 75-85% billable range, while partners may be closer to 30-40% billable, and admin staff may be 0-10% billable.
Designers aren’t able to bill their customers for every hour they work on their project. They may spend time fixing errors, researching codes, or other tasks that they don’t want to charge their customers for. The ratio of time spent on projects compared to the hours billed is called the billable ratio.
3. Billable ratio
The billable ratio is the percentage of potential billable hours that are actually billed. If an architect spent 100 billable hours in a given month and their hourly rate was $150/hour, $15,000 is the potential revenue for the firm. But if you’re only able to bill $11,000 of that potential revenue, that could be an issue that deserves more attention.
Here’s the formula to calculate a firm’s billable ratio:
Billable Ratio = Actual Revenue ÷ Potential Revenue
The ratio is calculated by taking actual revenue divided by potential revenue. In the example above, the billable ratio is 75% ($11,000/$15,000).
Gray says that high-performing firms usually have a billable ratio of at least 90%. Some firms can actually get over 100% with fixed fee contracts, where design efficiencies can translate into a billable ratio over 100%. These teams find a way to get the work done faster than estimated, leading to additional profit.
Continual improvement is the goal
By calculating these key performance indicators, and reviewing them on a regular basis, architectural firms can detect issues before they become serious problems and affect the company’s profitability.
A company’s break-even point fluctuates based on salaries and other business expenses and should be reviewed on a regular basis to ensure that the company is billing enough for its work. Utilization rates and billable ratios can be improved by increasing efficiency and reducing time spent on non-billable work.
Of course, all this is a moot point if the firm isn’t getting paid by its customers. Without cash inflow, companies have no way to pay their employees and vendors. Design firms can ensure that they get paid by taking advantage of their right to file a mechanics lien in the states where it’s allowed. In addition, sending preliminary notices and notices of intent to lien can often speed up the payment cycle.