Practice Management - Financial Management Flashcards
What are 2 broad categories of accounting?
- General Ledger Accounting
2. Project Cost Accounting
General Ledger Accounting
Provides firm-wide statements about the overall financial status of the business so that firm owners can make decisions crucial to the firm’s profitability and survival.
- Aka basic accounting
- All businesses must do this
Project Cost Accounting
Tracks revenue, expenses, and profit by individual projects.
- Vital for professional service businesses that depend on knowing how the amount of time spent on specific projects affects the financial health of the firm.
- Important in differentiating between projects that are making money vs losing money.
- Reports help managers decide how to allocate resources, manage projects, and develop accurate proposals for new work.
Accounts payable
Basic financial management term.
Amounts owed to the suppliers of goods or service (ex. consultants, utilities) that have not yet been paid.
Accounts receivable
Basic financial management term.
Money that others owe to the business through invoices for services.
Assets
Basic financial management term.
Any type of tangible or intangible resources that can be measured in monetary terms, including assets, fixed assets, and current assets.
Assets = liability + owner’s equity
Current asset
Basic financial management term.
Cash or an asset expected to be converted into cash within 1 year.
Ex. cash, accounts receivable
Fixed asset
Basic financial management term.
Resources that a firm uses and retains for a long period of time, such as equipment and property
Chart of accounts - what is it? For what reports is it developed? For what does provide a foundational format?
Basic financial management term.
List of various accounts that a business uses to track money, along with corresponding account numbers used for data processing. Account numbers are often listed as the last 4 digits of the full account number.
It is developed for the profit-loss statement and balance sheet, and provides a foundational format for the annual budget.
Direct labor
Basic financial management term.
AHPP: Same as direct salary. Represents time charged to projects, whether invoiced or not (by everyone, including principals).
Ballast: All labor of technical staff, principals, and support staff that is directly chargeable to projects.
What is direct expense? What is direct personnel expense (DPE)? What is direct salary expense (DSE)?
Basic financial management term.
Direct expense: 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.
Direct personnel expense = (expense of employee salaries) + (cost of mandatory and discretionary expenses and benefits like payroll taxes and health insurance)
Direct salary expense: Direct salaries of all the architect’s personnel engaged on the project, excluding the cost of fringe benefits (payroll burden).
*Direct personnel expense and direct salary expense is included in direct expenses, but not all direct expenses are direct personnel expenses.
Discretionary distrubution
Basic financial management term.
Voluntary distribution of profits to owners and non owners, such as performance bonuses, profit sharing and incentive compensation.
- viewed by some architectural firms as a necessary expense to attract qualified personnel, and by others as a profit-related item
Gross revenue Gross profit (from projects)
Basic financial management term.
Gross revenue: All the revenue generated by a business during a stated period of time.
Gross profit: revenue remaining after direct (project) expenses are subtracted from project revenues.
Net operating revenue (or net revenue)
Basic financial management term.
AHHP: Represents the net dollars remaining after deducting the invoiced consultant’s fees and expenses, and all reimbursable and non-reimbursable project-related expenses.
Ballast: The money that remains from billing after deducting consultant fees and expenses, reimbursable expenses, and non-reimbursable expense.
What is indirect labor?
Indirect expenses?
Basic financial management term.
AHHP:
- Indirect labor: 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.
- Indirect expense: General and administrative non-project-related operation expenses (includes indirect labor).
Ballast: All labor not charged to a specific project or revenue-producing account
- ex. administration, general office time, marketing
Liabilities
Current Liabilities
Long-Term Liabilities
Contingent Liability
Basic financial management term.
AHPP: Debts or obligations of the firm owed to others. They may be subdivided as current liabilities (due within one year) and long-term liabilities (due beyond one year).
Contingent liability = Liability that is not absolute and fixed but dependent on the occurrence of some uncertain future event or the existence of an uncertain specified condition.
Ballast: Claims by people outside the business and claim by the owners of the business against the total assets of the business.
- ex. money owned on a loan, mortgage, etc.
Other assets (besides fixed and current)
Basic financial management term.
Miscellaneous resources such as securities and copyrights.
Overhead / Indirect Expense / G&A (general and administrative)
Basic financial management term.
Expenses incurred to keep a business operating whether or not any revenue is being generated; expenses not directly related to any projects.
- ex. fringe and discretionary benefits, indirect labor/salaries, rent, software leases, fees for power/telephone services
What is one of the highest percentages of overhead?
Indirect labor
What are 2 basic accounting methods?
- Cash accounting
2. Accrual accounting
What is cash-basis accounting?
1 of 2 basic accounting methods where:
AHPP: 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.
Ballast:
- Revenue and expenses are recognized at the time the business receives the cash or pays the bill.
- Revenue and expenses are grouped into individual accounts for purposes of auditing, review, tax preparation, management, and analysis (ex. separate accounts for wages, rent, supplies, etc) = this is also done in accrual accounting method.
Advantages:
- Better at tracking actual cash flow
- Fairly simple
Often used by sole-proprietors and other small businesses.
What is accrual accounting? What are its advantages? What type of business usually uses this method?
1 of 2 basic methods of accounting in which:
- Revenue and expenses are recognized at the time they are earned or incurred, whether or not cash exchanges hands.
- Uses double-entry booking
- Revenue and expenses are grouped into individual accounts for purposes of auditing, review, tax preparation, management, and analysis (ex. separate expense accounts for wages, rent, supplies, etc) = this is also done in the cash accounting method
Advantages:
- Gives a better picture of a business’s long-term financial status
- Provides information that is important for active financial management
- Required by the IRS to be used by businesses above a certain size.
Double-entry booking
AHHP: A system of keeping books of an accounting which there are always two entries, a debit and a credit, for every transaction.
Ballast: A type of booking used in the accrual accounting method where all transactions are:
- listed chronologically in a journal
- posted to a ledger where transactions are grouped into individual accounts
What is modified accrual basis?
A slight variation of the accrual method typically used by architecture firms that:
- records fee revenue, expenses billed to client, and invoices to the firm by outside clients
- does not include amounts of fees that have been earned but not yet billed to the client
- This means revenue is based only in 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.
Balance sheet:
what is it? what is its core formula? what 4 key financial indicators does it provide?
An accounting report or statement that summarizes all assets and liabilities and shows the current financial position of the business.
- all listed assets must equal listed liabilities, aka:
(total assets) = (total liabilities) + (net worth or owner’s equity)
Includes these 4 key financial indicators to calculate from each month’s financial report:
1. Solvency or Current ratio:
Measures a firms ability to pay current debt.
Formula: total current assets / total current liabilities
Target ratio: min 1.5 to 1.0
- Liquidity or Quick ratio:
Measures a firm’s ability to convert assets to cash.
Formula: (cash + accounts receivable + revenue earned, but not billed) / total current liabilities
Target ratio: min 1.0 to 1.0 - Leverage or Debt-to-Equity ratio:
Measures a firm’s ability to manage debt effectively as a %.
Formula: total liabilities / total equity x 100 (as a percentage)
Target: < 35% or <2 - Return on equity:
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 x 100 (as a %)
Target: = or > than the anticipated net profit in the annual profit plan, typically 20% or greater
What is the mathematical structure of a balance sheet? What is a very important part of the balance sheet?
(total assets) = (total liabilities) + (net worth or owner’s equity)
The net worth of the business or owner’s equity is very important to balance sheets since total assets must equal the total liabilities plus the net worth or owner’s equity.
Net worth
Total assets less the total liabilities (aka mathematical structure of balance sheets)
aka what is owned minus what is owed
Owner’s Equity
Money invested in the business by owner’s or stockholders.
Profit and loss statement (or income statement):
what is it? what 7 key financial indicators does it provide?
An accounting report or statement that lists all the income and expenses of a business for a certain period of time.
- The difference between all income and all expenses yields either a profit or loss for that period
- reflects the results of a firm’s operations in terms of its revenue, direct labor, indirect labor, indirect expenses, and net profit for a given accounting period (typ current month and year to date)
Includes these 7 key financial indicators to calculate from each month’s financial report:
- Utilization rate
- Overhead ratio
- Break-even rate
- Net multiplier
- Profit-to-earnings ratio
- Net revenue per employee
- Aged accounts receivable
What is a Cash flow statement? Why is it important?
An accounting report or statement that shows actual inflows and outflows of cash or cash equivalents.
It is important because a business’s month-to-month financial health depends on being able to meet payroll and pay bills.
What does the term “cash” mean in accounting/finances?
money, checks, or anything else accepted by banks
What does the term “cash equivalents” mean in accounting/finances?
short-term investments that can be quickly converted into cash
- ex. short-term certificates of depot
What is financial management?
Beyond basic bookkeeping and accounting activities.
- Includes active planning, monitoring, and controlling of financial information AND acting on that information
What is the most fundamental equation for financial planning in any profit-oriented business? What are two ways to interpret it?
profit + expense = revenue
(organizing the formula like this suggests that the business will make its targeted profit and the business must then control expenses and generate the appropriate revenue)
revenue - expenses = profits
(organizing the formula like this suggests that profit is whatever may be left over after expenses are subtracted from revenue)
What is the main way to control expense?
Reduce overhead cost wherever possible.
What are 2 main ways to increase general revenue?
- Increase how much work the firm does
or - Increase fees
What is a project progress report? How is it helpful to a firm?
A report helpful to an architecture firm other than basic accounting reports.
A detailed, computer-generated version of the manually produced charts for a single project. It shows:
- hours and labor costs for each phase of a project, both current reporting period and total to date, and compares them with estimated hours and costs
- direct costs (ie for consultants, overhead allocations, and reimbursable expenses)
It gives project manager and firm management accurate state of a project and can be used to take corrective action as necessary
What is an office earnings report? How is it helpful to a firm?
A report helpful to an architecture firm other than basic accounting reports.
It summarizes each of the firm’s projects in terms of:
- amount of revenue generated
- expenses occurred
- unmilled services
- percentages of completion
- profit to date
It can help firm management find any projects that may be hurting overall profitability and need remedial action.
Ages accounts received report
A report helpful to an architecture firm other than basic accounting reports.
Shows statuses of invoices for all projects whether or not they have been paid.
What is the “age” of an invoice? What is the average collection period for invoices?
The time from invoice date to payment or current date if unpaid.
- unpaid invoices > 60 days old need attention from principal or collections
- average collection period for invoices = 60<75 days
- an invoice older than 90 days = firm is effectively lending money to the client without charging interest
What is a time analysis report? How is it helpful to a firm?
A report helpful to an architecture firm other than basic accounting reports.
Lists each employee along with the number of hours they have spent on direct labor, indirect labor, vacation time, sick leave, and holidays.
It helps managers calculate the chargeable ratio (or utilization rate) of employees
Utilization rate (or chargeable ratio)
formula:
(% of time (or dollars) spent on direct labor) / (total time (or dollars) spent on direct labor, indirect labor, vacation time, sick leave, holiday)
AHHP: Direct labor expressed as a percentage of total labor. For individual rates, use hours; for a firm rate, use dollars.
What is the chargeable ratio (aka utilization rate) for an entire firm that typically is the break-even point
65%
What is the general range for chargeable ratio for professional and technical staff? For principals?
75%-85%
below 75% due to time spent managing the firm
What is the current ratio (aka solvency) formula and what does it measure? What is a good current ratio for a healthy business? What is the min acceptable ratio for business health?
= (total current assets) / (total current liabilities aka debts)
- Measures a firm’s ability to meet current obligations or pay current debt
- The higher the ratio the better
- 1.5 = healthy business
- 1.0 = min acceptable
Net profit (NP) = ?
Net profit before tax ratio (NPBT ratio) = ?
Current earnings = ?
NP = NOR – (total direct and indirect labor + total indirect expenses)
*calculated before any distributions are made or tax is paid. Also called net income.
NPBT ratio = net profit / NOR
- one of the most important metrics of a company’s performance
- since it does not include tax, it reduced one variable which could influence final financial data results
Current earnings: The net dollar amount after all distributions are made and all applicable taxes have been deducted.
How do you calculate the overhead rate?
What is a good range for the overhead rate?
What does it tell you?
What is the break-even rate? What does it tell you?
What is a markup?
What is profit margin? What are the units for a profit margin?
= (total office overhead aka total indirect expenses) / (total direct labor)
direct labor = (hourly salary of employee) * (chargeable hours worked in a time period)
1.3-1.5
It tells you how the amount you need to spend on your cost of business per $1 you spend on salary while someone is working on a project in order to keep your business running. Aka rent, taxes, software, salary when people are not working on projects are all 1.3-1.5 times the amount that you are paying people to do billable work, and you can’t directly bill this to a client. However, you have to get that money coming in. That’s where the break-even rate comes in.
Break even rate = Overhead rate + 1
How much you need to make to break-even on your expenses. You need to add a markup (ex. 20%) in order to make a profit.
Markup = however much you add to the break-even rate in order to make a profit
Profit Margin is a ratio that tells you how much money you are making:
profit margin = (Total cost you have charged – Break-even cost)/Total cost = xx% – percentage!
Quick ratio aka Liquidity
refinement of the current ratio, measures a firm’s ability to convert assets into cash
= (only cash and cash equivalents + accounts receivable + revenue earned but not billed) / total current liabilities
Ideally > 1
It shows the company’s capacity to pay its current liabilities without needing to sell its inventory or get additional financing.
What is revenue per technical staff?
How can it be used?
= (amount of net revenue) / (# of technical staff members)
- can be used to estimate required net operating revenue for future budgets
- If firm’s operating revenue is known, revenue per technical staff can be used to estimate staffing levels.
Revenue per total staff
= (annual net operating revenue) / (total # of employees) / year
- can be used to estimate required net operating revenue for future budgets
- if firm’s operating revenue is known, revenue per employee can be used to estimate staff levels
Reimbursable expenses
AHPP: Project-related expenses that are invoiced to the client in addition to fee. These would also include markup percentage on those expenses. The markup dollars are a form of revenue and are included in net operating revenue.
Ballast: Costs and charges incurred by the architect that directly attribute to a project
- ex. mileage, food during travel, plotting/printing, courier services, etc
- does not include architect’s normal overhead
What is the most common method for setting fees?
Charging a billing rate, aka hourly rate per staff member working on a project
What is an hourly billing rate? How is it determined?
Hourly rate per staff member working on a project.
Determined based on:
(employee’s salary) + (cost of that employee’s fringe benefits) + (cost of office overhead) + (allowance for profit)
Calculations are often simplified by a net multiplier
Fringe benefits
Benefits generally not included in an employee’s taxable income
- ex. health insurance, retirement plan contributions, childcare assistance, fitness access, etc
Net multiplier
It is the measure of return on every dollar of direct labor, and often used to simplify billing rate calculations.
= (NOR, excluding consultant’s fees and reimbursable fees) / (total direct labor)
“total direct labor” = the cost of labor that is directly chargeable to projects, including:
- employee base salary
- fringe benefits
- indirect labor
- overhead
- profit
So, the net multiplier accounts for how much you pay your employee, how much overhead is spent on that employee, and whatever is leftover for profit.
Recommended rate = 2.7 < 3.0
Break-even rate
The overhead rate plus he unit cost of 1.00 for an hour of salary.
= overhead rate + 1
or
= (total cost of operations) / (total money spent on direct labor)
- recommend rate = 2.30 < 2.50
- multiply it by the employee’s base hourly salary to get the minimum hourly fee that must be charged to client in order to break-even on employee’s salary
- similar to net multiplier
- can be used to simplify billing rate calculations
- break-even rate accounts for salary of the employee and amount of overhead attributed to employee
How do you calculate the minimum hourly fee that must be charged to client in order to break-even on employee’s salary?
How do you use the minimum hourly fee to determine the hourly fee?
(employee’s base salary) x (break-even rate)
Increase min hourly fee by whatever percentage of profit is wanted to arrive at hourly fee
How is direct personnel expense (DPE) used as a multiplier similar to net multiplier?
= (direct personnel expense) / (net revenue, excluding consultant’s fees and reimbursable expenses)
- costs of providing taxes, benefits, etc are included with the employee’s salary
- multiplier is then calculated to account for indirect labor and profit
- multiplier is slightly lower than net multiplier since benefits are already included in DPE, so it is not as commonly used as net multiplier
Mechanic’s Lien - what is it? When should you consider filing it?
A right to keep possession of property belonging to another person until a debt owed by that person is discharged.
Consider filing a lien against a client’s project in the face of nonpayment over 90-120 days. An attorney should be consulted to comply with state laws.
What are 4 basic steps to collecting accounts receivable?
- Contract Terms
- Timely billing
- Complete invoices
- Regular procedures for tracking accounts
How do contract terms help a firm to collect accounts receivable?
What are 5 billing-related items/conditions that a contract should include?
It’s important have a clear understanding with the client before work starts about fee and how it will be paid
Contract should include:
- basis for fee
- when invoices will be sent and in what form
- when payment is due
- penalties for late payment (ie. interest charges after 45 days)
- provisions for nonpayment = stopping work on a project until work has been received (use attorney for language)
How can timely billing help a firm collect accounts receivable?
What are 3 things the architect/firm can do for timely billing?
- Delays in billing = delays in payments
- Faster billing helps clients to associate invoice with work performed during the billing cycle and may forestall questions.
- Send invoices as soon after the pay period as possible
- Bill twice a month min, once a month max
- Avoid agreeing to a lump sum payment at the end of phase completion, which can delay cash flow for months
Why should an invoice be easy to read and understand? What should an invoice include in order to be easy to read and understand?
- Be easy to read and understand so as to avoid questions and delayed payment
- Name and address of the client
- Project name and number
- Reference to a contract
- Detailed breakdown of work performed and billing associated with each item,
- Reimbursable expenses with backup documentation
- Name/number of person to contact with any questions
- Consistent format
What are 2 invoice formatting options?
- Breakdown of time each member spent on the job, their billing rates, and total cost
- Itemization of each phase of work or work task that was outlined in the contract
What are regular procedures that a firm should have for tracking accounts?
Additional suggestions for collecting fees?
- Maintain a company policy on how to handle accounts receivable
- Follow up on an invoice if payment not received after 2 weeks
- Additional actions in accordance with contract taken after 30 days
- Keep a written record of all the office’s actions regarding collections
- At beginning of project, verify client’s billing procedures and be familiar with them (ie who to send invoices to, specific format or information, etc)
- Use personal approach to collect fees
- Use software that develops aged accounts receivable, and deal with oldest accounts first
- Plan for cash flow (cash flow reports)
- Consider offering a 1-2% discount for payments made within a short time frame (ie 1-2 weeks)
- Require 10-20% retainer before work starts (if client objects, red flag for financial solvency)
- Beware of delaying tricks – as long as a firm has fulfilled its contractual obligations do not be dissuaded from aggressively seeking payment
- Be prepared to file a lien against a client’s project, consults a lawyer for state law
If a firm’s involvement with a project is expected to last more than year, what financial provisions should be included int he contract?
Provisions that allow for renegotiation of terms, billing rates, and other financial considerations that may change with time.
Why is it important to control overhead?
Keeping it to a minimum will increase the firm’s profits or allow a firm to offer lower fees than the competition.
What is the single largest overhead expense? How is it controlled?
What are other ways to minimize overhead?
Other ways for controlling overhead expenses?
Non-billable labor
- high priority to minimize
- important to carefully control time reporting
Report all significant non-labor direct expenses (aka chargeable expenses often thought of as overhead):
- progress prints
- copy machine use
- computer expenses charged by outside company
- model supplies
- postage/delivery
- local travel expense
- presentation supplies
- Firm office location/rent
- Best princes on phone service, internet, etc
- Firm’s insurance policies (ex. health and project)
- Team up with other firms on to shareholders costs of continuing education / share info
What type of report would a project manager use to determine the utilization rate of an employee?
Time analysis report
What type of report would help a project manager determine which projects may be hurting overall profitability and may need remedial action?
Office earnings report
What type or report would help a project manager an accurate state of a project and know whether or not they need to take corrective action?
Project progress report
Profit-to-earnings ratio
Part of a Profit and Loss statement. Measures the firm’s effectiveness in generating a net profit (as a %).
Formula: net profit (before distributions and tax) / net operating revenue
Target: = or > 20%, or the anticipated net profit in the annual profit plan
What are the 4 most significant line items on the Profit-Loss Statement?
- Net operating revenue (dollars available for supporting daily operations and the baseline 100% value of the rest of every line item in the report)
- Total direct labor, as a percentage of NOR.
- Total expenses
- Net profit (before distributions and tax and referred to as the “bottom line”
What is the “bottom line” of the P-L statement?
net profit
What are the 4 most significant line items of the Balance sheet?
- Current assets: Those easily converted to real dollars
- Current liabilities: Items that must be paid within the current 12-month period, irrespective of the calendar year, that diminish the value of a firm’s retained earnings and thereby reduce equity.
- Long-term liabilities: Items that must be paid beyond the current 12-month period and diminish the impact of the value of a firm’s retained earnings (and thereby reduce equity)
- Equity: The value of shares of stock, invested capital by shareholders, and the firm’s cumulative retained earnings (or loss)
* note: current assets (cash-on-hand, accounts receivable, and fees earned unbilled) are line items that need careful, regular scrutiny to ensure that the firms maintaining a proper margin over its liabilities.
What data is shared from the profit-loss statement to the balance sheet? From the balance sheet to the profit-loss statement?
- bad debt
- current earnings
- accrued bonus
- accumulated depreciation/amortization
bad debt
a debt owed to the firm that is uncollectible (ex. invoiced amounts on aged accounts receivable that can be written off due to clients’ failure to pay)
What does the cash-basis profit-loss statement define?
available cash
What does the accrual-basis profit-loss statement define?
net profit
What 2 financial statements should be checked before distributing net profit?
cash-basis profit-loss statement and accrual-basis profit-loss statement
Aged accounts receivable
- Can be calculated from P-L statement
- 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 operating revenue ÷ 365 days) = calendar days before payment 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.)
top-down budget
A type of budget where the agreed-upon fee for services is set first (at the top of a balance sheet) and the work effort is derived from it (working downward). Usually the basis of a fixed fee proposal.
hourly not-to-exceed (NTE) proposal
A type of cost proposal where the architect invoices the owner for all costs of basic services incurred on the project, up to a predetermined fixed limit that will not be exceeded. Generally, the most fair for both parties; gives the owner predictability for budgeting and the architect some flexibility in fee.
hourly fee proposal
A type of cost proposal where the architect invoices the owner directly for all costs of basic services incurred on the project (assessed hourly) with no fixed limit. The owner is not able to completely predict the cost of service.
fixed fee proposal
A type of cost proposal where the fees for the architect’s services are predetermined, giving the owner more predictability in the soft costs of the project. The architect typically is more at risk in this scenario, as it is difficult to accurately predict the amount of effort that may be required over the life of a project.
bottom-up budget
A type of budget where the work effort is estimated first (usually at the bottom of a balance sheet) and then the total fee required to perform the work is determined from it (working up toward the top of the sheet).
operating expenses
Expenses incurred in conducting normal business operations. Operating expenses may include wages, salaries, and administrative and marketing/business development costs, but excludes interest, depreciation, and taxes.
net 30
A term used to describe the relationship between the generation of an invoice and the time expected to pay that invoice. Usually 30 days. Unpaid invoices beyond this limit are referred to as aged invoices.
capital
The total assets a company or firm carries on a balance sheet. Also used to describe the net worth of an owner’s equity accounts, including real estate, cash, and other accumulated wealth.
backlog
A value of anticipated revenue based on contracted projects that still have portions of work yet to be performed. Backlog increases for every project commission secured.
release of lien
The ending of a mechanic’s lien, it is the document stating the contracted worker or provider of materials or services releases the responsible party from obligation, after the party has satisfied the terms and requirements of the lien.
lien wavers
The document by which someone holding a mechanic’s lien against another waives his right to the claim.
Write off
The transfer of an amount previously regarded as an asset (e.g., an account receivable) to an expense account or to the profit-and-loss account.
