Mike Webber is an experienced CFO, consultant, and owner of A/E Finance (www.aefinance.net, firstname.lastname@example.org). He worked on this survey on behalf of ACEC’s Management Practices Committee. ACEC collaborated with Deltek on the 2012 Clarity A&E Study. These are some additional observations he made from the study.
By now, I hope everyone has gone through Deltek’s 2012 Clarity Architecture and Engineering Industry Study on 2012 industry financial performance. In further going through the “Statistics at a Glance” section, I came up with some additional information that I found of particular interest – the full cost of people.
It is almost a cliché to state, “Our People Are Our Most Important Assets.” They are also the most expensive, and the proof is in the numbers.
From the Income Statement:
By simply adding the studies Direct Labor per Employee and Indirect Labor per Employee gives Total Labor per Employee, in other words average, or total, pay per Employee. However, salaries & wages are not the only cost of people. There also are the other payroll-related expenses, such as the statutory taxes (FICA, Medicare, etc.) the firm must pay; group health, life, etc. insurances; 401(k) matches & other pension plans; and any other employee benefits related to payroll. Therefore, the total cost of an employee is much higher than just their salary or hourly wage. Here is a summary from the Deltek Clarity Survey. (All $ amounts are per Employee.):
- It is remarkable to a finance / numbers person how consistent all these numbers are across the different categories, with the exception of High Performers’ bonuses. Obviously, they recognize and appreciate the people who made them High Performers. (Note: Bonuses are not an Operating Expense; they are recorded below the Operating Profit line along with Interest and Other Income & Expense. Bonuses are a discretionary distribution of Operating Profits to employees, including owners, for performance, but do not include distributions of profits / Retained Earnings to owners on the basis of share holdings.)
- I do not think that most firms – and certainly most employees – realize how much “other” expenses they pay for employees in addition to the salaries and wages. It is over 20% more. The average employee salary is in the mid- to upper $60Ks, but the average total cost of each employee is in the low $80Ks – and these amounts vary little across groups!
- Most important is to recognize how much the full cost of people is of Total Operating Expenses. ‘People’ are the key to any A/E firm. It is the hours and talents of our ‘people’ that we ‘sell’, and we spend 75% to 80% of Total Operating Expenses on them. That means that all other overhead items total only a bit over 20% of Total Operating Expenses. Take away large OH items like rent and insurance policies, which are negotiated at most annually, and even capital expenses, which show up as depreciation, and there is little in OH that can be controlled or managed day-to-day, or even during the year. Operational results – and overall financial performance – depend on how efficiently and effectively we manage our people and our projects on a day-to-day basis.
- The two particular metrics that track how efficiently & effectively firms use staff – and 75% to 80% of expenses – are Utilization Rate and Net Labor Multiplier. (Not shown here; see original Study.) Surprisingly, there is very little variance in overall firm Utilization Rates across the different groups. In fact, PSMJ research indicates that a firm’s overall Utilization Rate has barely a 1% correlation to a firm’s profits. The key, then, is the Net Labor Multiplier, which can – and should – be monitored on a project-by-project, phase-by-phase basis each billing period.
From an Invested Capital Perspective (Again $ amounts are per Employee):
- Fixed Assets per Employee reflects even more money that is invested by owners in each employee, be it in the form of desks, computer equipment & capitalized software, and leasehold improvements, essentially FF&E. It is possible that the larger number for Large 251+ firms also reflects an amount of Goodwill resulting from possible acquisitions that have taken place.
- Technically, Working Capital is Current Assets minus Current Liabilities. Essentially, it is mostly Cash plus Accounts Receivable and Work-In-Process minus Accounts Payable to consultants and other vendors. Once more, it is a reflection of the amount owners have invested in the firm, per employee, to pay salaries and other OH expenses while they wait 60 to 90 days to collect the invoices sent to clients.
- The only category that is significantly different is Working Capital and Total Equity per Employee within the High Performer firms. I can only speculate as to why High performers’ numbers are so much higher. It probably is not that they have significantly higher Accounts Receivable or lower Accounts Payable. That leaves Cash as the likely item that is much higher for High Performers. Whether owners are leaving more money within their firms to support internal growth, acquisitions, or to weather downturns in the economy and business, I do not know, but there is something that High Performers are doing that likely is supportive not just of their significantly higher financial performance, but also of their strategic plans.
- Despite their higher Working Capital & Equity levels and higher Bonuses per Employee, the High Performers’ Operating Profit Rates (25% vs. 8.3% for All Other Firms) still result in, by far, higher Pre-Tax Returns on Total Equity (46.5% vs. 17.1% for All Other Firms).
Benchmark Yourself Against High Performers
It is worth again going through the Deltek Clarity Study if only to compare your firm against the High Performers’ results. A hint: High Performers exceed all other groups by far in Net Labor Multiplier (Net Revenue / Direct Labor), and in the amount of money they retain within the firm (Working Capital, probably Cash).
Note: Benchmarking is a financial – not accounting – activity through which the analysis determines why the most important benchmarks vary. It is not just a matter of lining up a firm’s numbers next to the benchmark numbers. Many firms attempting this for the first time may be well served having a knowledgeable outside person or firm with expertise in the A/E industry assist in this effort.
In addition to benchmarking annual results, it should also always be done prior to any and all financial, strategic and business planning sessions, and the terms and variances understood by each person who will be involved in those sessions. The final planning results should then include the actual targets the firm plans to achieve during the period being planned, with action items to be executed, and the monitoring systems to be used, in order to meet those targets.