2.1: Evaluate the Financial Well-Being of the Practice

Question 1

Additional services

Answer 1

Professional services that may, if authorized or confirmed in writing by the owner, be rendered for additional compensation, in addition to the basic services identified in the owner-architect agreement.

Question 2

Aged Accounts Receivable

Answer 2

Formula: Average annual accounts receivable ÷ (NOR ÷ 365 days) = calendar days before payment is received. This metric shows how long after invoicing it typically takes to receive payment. A target for this metric is no greater than 90 days.

Question 3

Annual Budget

Answer 3

One of two financial management system documents, this document provides an outlook for the upcoming year in terms of projected revenue and expenses. Once created for the year, it should remain untouched and should be compared to the PL statement each month to determine if the firm is on track towards their goals.

Question 4

Asset

Answer 4

As a matter of accounting, any resource that has some economic value to a person or business. Examples include vehicles, property, furniture, equipment, etc.

Question 5

Balance Sheet

Answer 5

One of two financial reports used by firms, this document shows where a firm is financially at the current moment in time. It’s used alongside the PL statement to evaluate the firm’s financial position.

Question 6

Break-Even Rate

Answer 6

Formula: Overhead Rate + 1.0. This number represents the costs to pay for your overhead and salaries - essentially, the minimum multiple of an employee’s salary that you could charge in order to not lose any money. Firms should target 2.3 to 2.5 as a metric.

Question 7

Business Plan

Answer 7

A document that firms create to guide their decision-making process. It’s typically broken down into four sections: purpose, finance, operations, and marketing. This document should be continually referenced and updated given changes in the firm’s strategy, market, or the economy in general.

Question 8

Cash flow

Answer 8

The money that a business takes in or pays out for services rendered and expenses incurred.

Question 9

Cost per Unit

Answer 9

A fee structure where the architect charges based on a number or amount of things that they design - it could be based on the square footage of the project, number of hotel rooms, or some other factor.

Question 10

Current Ratio

Answer 10

Formula: total current assets / total current liabilities. This metric measures a firm’s ability to cover their debts, which is a measure of solvency. Firms should target 1.0 -1.5 as a metric.

Question 11

Debt-to-Equity Ratio

Answer 11

Formula: total liabilities ÷ total equity × 100 (to determine %). This metric measures whether a firm is effectively leveraging debt in order to grow their business. Business strategies differ on this topic, but in general firms should target less than 35% as a metric in order to not be over-leveraged.

Question 12

Direct Labor

Answer 12

This figure can be measured in either hours or dollars - it represents either the time spent, or the resultant cost of, work on client’s projects. It either has been or will be invoiced to the client.

Question 13

Efficiency-based firm

Answer 13

One of three common business models for architectural firms, this type of firm has a large proportion of lower-level production staff members compared with more experienced staff members, and seeks to produce relatively simple and repetitive projects quickly and on a tight budget.

Question 14

Equity (finance)

Answer 14

The value of shares held in a company, which represent an ownership interest.

Question 15

Experience-based firm

Answer 15

One of three common business models for architectural firms, this type of firm has a proportionate number of staff members at all levels of the firm. They produce a variety of project types and are able to complete projects of high complexity.

Question 16

Expertise-based firm

Answer 16

One of three common business models for architectural firms, this type of firm relies on the knowledge of one or a few highly skilled architects to produce their work. They typically work on specialized projects that require their unique perspective.

Question 17

Indirect expenses

Answer 17

General and administrative operating expenses that are not attributed to specific projects.

Question 18

Indirect Labor

Answer 18

Work spent on non-billable tasks, either by an employee or the firm as a whole. This amount is not billed to clients. Examples include working on marketing materials, responding to RFPs, and the firm’s material library.

Question 19

Invoice

Answer 19

A bill issued from a business to a client for services rendered.

Question 20

Net Multiplier

Answer 20

Formula: Net Operating Revenue (NOR) / Direct Labor. This number measures how many dollars must be earned for every dollar spent on direct labor, a.k.a. salaries. It must be higher than the break-even rate in order to realize a profit. When determining billing rates, you multiply an employee’s salary by this number in order to determine the billing rate. This metric is typically around 3.0 for most firms.

Question 21

Net Revenue Per Employee

Answer 21

Formula: Net Operating Revenue (NOR) / # of employees. This metric simply measures how much money, on average, each employee brings into the company over a given time period. Firms should target $100,000+ as a metric.

Question 22

Net Operating Revenue (NOR)

Answer 22

The total money your firm earns from projects after you subtract any costs associated with those projects, like payments to consultants and other expenses. It’s the amount left over that you can use to pay for running your business and to make a profit.

Question 23

Not-to-Exceed Price

Answer 23

A method of applying a maximum price that an architect’s fee will be, typically used in conjunction with the time-charge fee structure. This gives comfort to clients that there’s a cap on the amount that they’ll spend on architect’s fees.

Question 24

Overhead Rate

Answer 24

Formula: Total Indirect Expenses / Direct Labor. This number measures how much you spend on the operations of your firm, such as the office lease, equipment, etc., as a multiple of your employee’s salaries. Firms should target 1.3 to 1.5 as a metric.

Question 25

Percentage of Construction Cost (fee structure)

Answer 25

A fee structure where the architect’s fee is based on how much it costs to build the project. This fee structure fell out of favor in the industry because it appears to create a conflict of interests for architects - they get paid more if the cost of the project is inflated.

Question 26

Prime agreement

Answer 26

The architect’s agreement with the owner for the project. Typically, AIA Document B101.

Question 27

Profit

Answer 27

Formula: Revenue - Expenses. This represents the amount that’s left over after a firm pays for everything that’s required to operate their firm - salaries, office costs, consultant costs, etc.

Question 28

Profit-Loss (PL) Statement

Answer 28

One of two financial reports used by firms, this document shows where a firm is financially over a period of time, typically one month. It’s used alongside the balance sheet to evaluate the firm’s financial position.

Question 29

Profit-to-Earnings Ratio

Answer 29

Formula: Net Profit / Net Operating Revenue. This metric shows what percentage of the firm’s billings are not spent on salaries and overhead expenses. Firms should target minimum 20% as a metric.

Question 30

Profit plan

Answer 30

The comprehensive measures taken by a business to build the presumption of profit into their operations; this affects staffing, project schedules, fees, etc.

Question 31

Quick Ratio

Answer 31

Formula: (cash + accounts receivable + work in progress) / total current liabilities. This metric measures a firm’s ability to quickly convert assets to cash if necessary, which is a measure of liquidity. Firms should target at least 1.0 as a metric.

Question 32

Return on Equity

Answer 32

Formula: (total net operating revenue − total expenses) ÷ total equity × 100 (to determine %). This metric shows how much money is returned to stockholders or owners of the company, as a percentage of their total investment. Firms should target at least 20% as a metric.

Question 33

Revenue

Answer 33

The total fees received by a firm over a given period of time in exchange for providing services to their clients.

Question 34

Schedule of services

Answer 34

A document provided by a consultant that outlines their services and fees, usually with line items for each associated cost.

Question 35

Scope Creep

Answer 35

Scope creep occurs when the project scope unintentionally increases due to changes made to materials, quality, extent of work, etc. This can be due to a variety of factors such as owner request, the architect wanting to please their clients, etc. Though scope creep can occur at any point, during construction the architect must be aware of any scope creep in an effort to keep the project on time and on budget.

Question 36

Time-Charge

Answer 36

A fee structure where the architect charges a set fee for each hour worked on the project. This is perhaps the simplest fee structure and does not require any calculations on the part of the architect, other than knowing their staff members’ billing rates.

Question 37

Total Labor

Answer 37

The cost of your employees’ salaries; the sum of direct and indirect labor.

Question 38

Examples of Indirect Expenses

Answer 38

Office Lease + Office Equipment + Benefits, Salaries (non-billable) + Insurance + Accounting & Legal.

Question 39

How should the architect ensure that the provisions of the prime contract and consultant agreements are in alignment with each other.

Answer 39

Integrate the prime agreement as an exhibit into the consultant’s contract with the architect. Integrating the prime agreement into the consultant’s contract with the architect eliminates any possible doubt or chance of error in agreement with each other.

Question 40

Examples of Net Profit

Answer 40

Project Income (Revenue): $100,000

Direct Expenses: $40,000 (consultants, materials, etc.)

Indirect Expenses (Overhead): $30,000 (rent, office staff salaries, etc.)

Step 1: Calculate Net Operating Revenue (NOR) NOR = Revenue – Direct Expenses $100,000 – $40,000 = $60,000

Step 2: Calculate Net Profit

Net Profit = NOR - Indirect Expenses
$60,000 – $30,000 = $30,000

So, the Net Profit is $30,000.

Question 41

Example of NOR

Answer 41

PROJECT INCOME (what the client paid) - DIRECT EXPENSES (project-specific costs, ex: materials, Labor, and consultants.). Remaining revenue after direct costs. This is the revenue after subtracting Direct Expenses from Project Income. It is what’s left for the company to pay for indirect expenses and generate profit.