With the history of open-ended, time-based projects, architecture & engineering (AE) firms had a tendency to think that revenue equaled billings. This assumption proved problematic even in the past on lump sum projects.
The standard American Institute of Architects (AIA) phase-based billing terms were front-end loaded. This was great for cash flow as you could bill for 60% of the contract in the early phases of the design and only perform 40% of the work. The problem occurred when companies used billings as the basis of revenue when they were billing in advance on these contracts. The common refrain was “we blew it in construction administration.” The reality was there was very little fee left in the construction administration phase because it was taken prematurely in the early phases of design.
Firms take a financial killing because they do not understand how to determine progress on projects. Some small firms actually went out of business because they had earned most of the fee in the early stages of work and had no cash or revenue in the later stages of the contract and no new work. Because these firms used billings to determine revenue, it was not based on progress toward specific deliverables. Progress towards deliverables is an earned value approach and a much more accurate indication of project progress and how much revenue should be earned.
I know it seems strange but we have an instance here where the government comes to the rescue and we don’t mean a bailout. It is in the context of accurate assessment of project progress that the government can help. The U.S. government imposes earned value methodology on all contractors performing services for the government. Earned value is a method to determine how much progress is complete against specific contract deliverables.
In effect, the contractor can only be paid by the government for percentage of work complete. In Deltek’s experience, approximately 20% of firms have best practices with revenue recognition by using some form of percent complete or earned value to determine progress. The remaining 80% can take a page from the government’s playbook.
In today’s environment almost all design contracts are lump sum or time-based with an upset limit. As a result, all contracts need to be monitored carefully to ensure that they are on budget as overruns will not be reimbursed by the client. By understanding where you stand on each project you have a better picture of company performance and also what is required to finish each project. If the level of effort is more significant than the remaining fee and revenue, resources will need to be utilized but they will not earn revenue. This can have negative impact on financial performance and put a strain on resources that can no longer be deployed on profitable assignments.
The 20% of the firms with progressive practices use planning or budgeting software that includes all the deliverable items in each contract. The project manager assesses progress against each deliverable at least once per month and after review by principals or other senior managers this estimate is the basis for the revenue calculations. This provides greater confidence in the status of the projects and provides time to respond if a project is going off track in the earlier stages of the effort.
AE Firms that use Deltek Vision Planning on all projects and include individual staff in the plans get the additional bonus of resource management. These companies have greater insight into future staffing requirements, are able to anticipate the need for more resources and can assess candidates before it is a crisis, and achieve higher utilization by assigning staff by adjusting schedules to avoid bench time. They can also be more confident in schedule commitments they make with their clients.
Bob Stalilonis has provided design and best practice consulting to AE firms for more than 30 years.