How Should I Calculate Profit On My AE Projects

Part one of a three part series by Michael McCaffrey, Deltek Consultant

After working with hundreds of firms in the Architecture and Engineering industries, I can tell you one thing for sure; profit and how it is calculated is the most elusive of all moving targets. What some in the AE industry seem not to know is that it is feasible to produce breathtaking work that your clients will sing from the mountain tops about and still obtain a quality monetary return on that investment.

Profit is certainly not a four letter word and should not be avoided like the plague. Now that we are all in agreement of its importance, what does profit look like?

The following is the first of a three part series that will take you through the components of the profit equation and provide recommendations for how profits should be calculated on time & expense and fee type projects.

Part 1:  How should I calculate cost on my architecture or engineering projects?

Part 2:  How should I calculate profit on my time & expense billing projects?

Part 3:  How should I calculate profit on my fee type billing projects?

Part One:  How Should I Calculate Cost On My Engineering or Architecture Projects?

To derive profit from your projects, you must first understand the variables that are in play in the profit equation. The baseline in this equation is always cost, but what cost looks like depends on your method of thinking.

The first of my three part series on profitability focuses on cost and what is referred to as “burden.”

While my employee might make $25.00 per hour, we all know that it costs much more than this to have him or her working for an hour. I pay taxes and benefits on their behalf and I have overhead costs that must be covered to have him or her able to do their job. Factoring in these to my labor cost helps me truly quantify the real overall cost on my projects.

So, now I’ll ask – what does this “burden” look like? It is a product of two components: DPE (direct personal expense) and overhead.

Direct Personal Expense (DPE)

Direct Personal Expense, also known as payroll burden, is personnel-related overhead costs (such as vacation, sick leave, insurance, payroll taxes, pension expenses, and other benefits) that you add to labor cost for project reporting purposes.

Overhead

Overhead, which is not part of DPE, includes any operating expenses not directly related to employees. For example, these expenses can include rent, office expenses, utilities, business taxes, insurance, and so on.

Understanding, estimating, and tracking the cost of DPE and overhead is essential in running the day-to-day operations of all firms. It will allow you to obtain a true picture of your projects and to determine if your projects are PROFITABLE.

Methods for calculating DPE and overhead

You can calculate DPE and overhead in a variety of ways, with the most commonly used being:

Based on fixed percentages

–       w/ Direct labor + DPE as the base

Use this method if you want to calculate DPE separately from overhead. This method is most commonly used by architectural and engineering firms.

–       w/ Direct labor as the base

Use this method if you want to include DPE and overhead as a single calculation.

Calculating DPE and overhead based on fixed percentages

Although each accountant may have somewhat different methods for calculating DPE and overhead, here are some common guidelines. FAR (Federal Acquisition Regulation) requirements may also need to be considered for firms that work on government projects.

DPE % Calculation- Typically, DPE percent is calculated as follows:

Annual staff-related benefit cost total divided by direct salary cost

Example

$750,000 Cost of firm’s entire direct salary

$250,000 Cost of benefits

The DPE percent for the firm is:

(250,000 / 750,000) = 33.33%

DPE (cost value to project, using DPE % calculated above) – Project DPE is calculated as follows:

Direct labor cost X DPE percent

Example

$15.00 Hourly cost of an employee

33.33% DPE

The DPE is:

15.00 x .3333 = $5.00

Calculating Overhead – Separately From DPE

(using direct labor + DPE as the base)

You can track DPE separately from overhead when reporting project cost. In this way, you can evaluate your projects using burdened cost, which provides a more accurate picture in determining actual project profit. Use this method if you want to track your DPE separately from your general overhead expense when generating project cost:

Overhead percent – Overhead percent is calculated as follows:

Firm’s total operating cost (not including taxes or discretionary bonuses)

Minus direct labor, DPE, and direct expenses

Divided by direct labor cost + DPE

Example

$2,600,000 Firm’s total operating expenses

$750,000 Total direct labor

$250,000 DPE (cost of benefits)

$100,000 Direct expenses

The overhead cost is:

2,600,000 – (750,000 + 250,000 + 100,000) = 1,500,000

The overhead percent is:

(1,500,000 / 1,000,000) = 150%

Overhead (cost value to project, using % calculated above) – Overhead that is added to project labor cost is calculated as follows:

(Cost amount + DPE) x overhead percent

Example

$15.00 hourly cost of an employee

$5.00 DPE

150% Overhead

The overhead is:

(15.00 + 5.00) X 1.50 = $30.00

** Total “burdened” project cost – Burdened project cost is calculated as follows:

Cost amount + DPE amount + overhead amount

Example

$15.00 Employee’s hourly cost

$5.00 DPE

$30.00 Overhead amount

The total burdened cost rate for the employee is:

15.00 + 5.00 +30.00 = $50.00

Calculating overhead with DPE (using direct labor as the base)

Use this method if you do not want to track DPE separately from general

overhead expense when viewing project cost.

Overhead percent – Overhead percent is calculated as follows

Firm’s total operating cost (not including taxes or discretionary bonuses)

Minus direct labor and direct expenses

Divided by direct labor cost

Example

$2,600,000 Firm’s total overhead expense

$750,000 Total direct labor cost

$250,000 DPE (already included as part of total operating cost)

$100,000 Direct expenses

The overhead cost is:

2,600,000 – (750,000 + 100,000) = $1,750,000

The overhead percent is:

(1,750,000 / 750,000) = 233.33%

Overhead (cost value to project, using % calculated above) – Overhead is calculated as follows:

Cost amount x overhead percent

Example

$15.00 Employee’s hourly cost

233.33% Overhead percent

Overhead is:

15.00 x 2.3333 = $35.00

** Total “burdened” project cost – Burdened project cost is calculated as follows:

Cost amount + overhead amount

Example

$15.00 Employee’s hourly cost

$35.00 Overhead amount

The total burdened cost rate for the employee is:

15.00 + 35.00 = $50.00

To be able to put the arrow through the bulls eye of the moving target called profit, you must first qualify how and what you classify as cost.  Once you have used the simple calculation illustrated above, or a similar method, you have taken the first step to doing so.

You can read part two of our three part series on how to calculate profitability for architecture projects or engineering projects:   How should I calculate profit on my time & expense billing projects?