Financial Management

Question 1

Accrual-basis accounting

Answer 1

Revenue earned and billed from fees and expenses, including outside project consultant fees and expenses, plus all other direct and indirect expenses incurred. This means revenue is based only on invoiced fee and expense amounts sent and/or received. Most firms use this modified accrual-basis for their profit-loss statement and balance sheet development

Question 2

Cash-basis accounting

Answer 2

Income received and all salaries and expenses paid (a checkbook approach). This is the basis most commonly used for filing and paying quarterly and year-end taxes

Question 3

Net operating revenue

Answer 3

aka “net revenue”): Represents the net dollars remaining after deducting the invoiced consultant’s fees and expenses, and all reimbursable and non-reimbursable project-related expenses

Question 4

Direct labor

Answer 4

Same as direct salary. Represents time charged to projects, whether invoiced or not (by everyone, including principals).

Question 5

Indirect labor

Answer 5

Same as indirect salary. Time charged to non-project-related activities (by everyone, including principals). Note: Indirect labor is included in the calculation of total indirect expenses

Question 6

Reimbursable expenses

Answer 6

Project-related expenses that are invoiced to the client in addition to fees. These would also include a markup percentage on those expenses. The markup dollars are a form of revenue and are included in net operating revenue

Question 7

Direct expense

Answer 7

Project-related expenses for a firm and its outside consultants that are not reimbursable, plus project-related expenses included in all lump sum fee contracts

Question 8

Indirect expense

Answer 8

General and administrative non- project-related operating expenses (total indirect expenses includes indirect labor).

Question 9

Overhead rate

Answer 9

The ratio of total indirect expenses to total direct labor

Question 10

Break-even rate

Answer 10

The overhead rate plus the unit cost of 1.00 for an hour of salary (example: overhead rate of 1.30 + 1.00 = break-even rate of 2.30). This means for every $1.00 of salary the firm must recapture $2.30 just to break even

Question 11

Utilization rate

Answer 11

Direct labor expressed as a percentage of total labor. (For individual rates, use hours; for a firm rate, use dollars

Question 12

Hourly billing rate

Answer 12

The dollar amount charged to a client relative to one hour of direct labor

Question 13

Net multiplier

Answer 13

The net multiplier is the ratio of net operating revenue (NOR) to total direct labor. The measure of return on every dollar of direct labor

Question 14

Net profit

Answer 14

The dollars remaining after deducting all direct and indirect labor and indirect expenses, before any distributions are made or tax is paid

Question 15

Current earnings

Answer 15

The net dollar amount after all distributions are made and all applicable taxes have been deducted

Question 16

Utilization rate

Answer 16

Measures the overall efficiency and effec- tive use of labor, not a measure of productivity. This also is not a measure of the number of hours billed, only hours charged to projects.
Formula: direct labor hours ÷ total labor hours × 100 (as a %) Example: 32 hours ÷ 40 hours = 80%
Target: Entire firm: 60–65%
Professional-technical staff, including principals: 75–85%

Question 17

Overhead rate

Answer 17

Measures the cost of operations not directly attributed to projects.
Formula: total indirect expenses ÷ total direct labor (in $$$)
Example: $308,241 ÷ $200,914 = 1.53 (for an hourly salary of $10/hr., the overhead cost would be 1.53 × $10 = $15.30)
Target: 1.30 to 1.50 of total direct labor

Question 18

Break-even rate

Answer 18

Measures the total cost of operations for every dollar spent on direct labor.
Formula: overhead rate + 1.00 (represents the unit of cost for an hour of salary)
Example: 1.53 + 1.00 = 2.53 (for an hourly salary of $10, the break-even cost would be 2.53 × $10 = $25.30) Target: 2.30 to 2.50 of total direct labor

Question 19

Net multiplier

Answer 19

Measures the revenue generated for every dollar spent on direct labor. This indicator must be greater than break-even rate for a net profit to be realized.
Formula: net operating revenue ÷ total direct labor (in $$$)
Example: $622,207 ÷ 200,914 = 3.1
Target: Greater than break-even rate (industr y benchmark: 3.0+)

Question 20

Profit-to-earnings ratio

Answer 20

Measures the firm’s effectiveness in generating a net profit (as a %).
Formula: net profit (before distributions and tax) ÷ net operating revenue
Example: $108,817 ÷ $622,207 = 17.49%
Target: Equal to or greater than the anticipated net profit in the annual profit plan (20% or greater

Question 21

Net revenue per employee

Answer 21

Measures the revenue earnings for each employee. Based on targeted net profit, this indicator contributes to the establishing of the net operating revenue in the coming year’s annual budget.
Formula: annual net operating revenue ÷ total number of employees
Example: $622,207 ÷ 6 employees = $103,701 per employee
Target: In excess of $100,000.00 per employee

Question 22

Aged accounts receivable

Answer 22

Measures the average time interval in days between the date of outstanding invoices and the date payment is received.
Formula: average annual accounts receivable ÷ (net oper- ating revenue ÷ 365 days) = calendar days before pay- ment is received
Example: $245,090 ÷ ($622,207 ÷ 365 = 1,705) = 144 calendar days
Target: 60–90 calendar days (Anything over 90 days means the firm is ”lending” money to client at zero cost.

Question 23

Solvency

Answer 23

Measures a firm’s ability to pay current debt. This is also known as the “current ratio.”
Formula: total current assets ÷ total current liabilities Example: $521,667 ÷ $218,658 = 2.39
Target ratio: Min. 1.5 to 1.0

Question 24

Liquidity

Answer 24

Measures a firm’s ability to convert assets to cash. This is also known as the “quick ratio.”
Formula: (cash + accounts receivable + revenue earned, not billed [“work in progress”]) ÷ total current liabilities Example: $518,194 ÷ $218,658 = 2.37
Target ratio: Min. 1.0 to 1.0

Question 25

Leverage

Answer 25

Measures a firm’s ability to manage debt effec- tively. This is also known as “debt–to-equity” (as a %).
Formula: total liabilities ÷ total equity × 100 (as a %) Example: $280,738 ÷ $949,451 = 29.57%
Target: Less than 35%

Question 26

Return on equity

Answer 26

Measures the accumulated amount of money returned on a stockholder’s investment for their risk and efforts.
Formula: (total net operating revenue − total expenses) ÷ total equity × 100 (as a %)
Example: ($622,207 − $509,156) ÷ $949,451 × 100 = 11.9%
Target: Equal to or greater than the anticipated net profit in the annual profit plan (20% or greater)

Question 27

Balance Sheet

Answer 27

Significant line items:
Current Assets
Current Liabilities
Long-term liabilities
Equity

Includes the following four indicators to calculate from each month’s financial report:
Solvency
Liquidity
Leverage
Return on equity

Question 28

Profit-Loss Statement

Answer 28

Significant line items:
Net operating revenue
Total direct labor (% of NOR)
Total expenses
Net profit (before distributions and tax - "the bottom line")

Includes the following seven indicators to calculate from each month’s financial report
Utilization rate
Overhead rate
Break-even rate
Net multiplier
Profit-to-earnings ratio
Net revenue per employee
Aged accounts receivable