The Ultimate Guide to Budgeting for Architecture and Engineering Firms Part 4

By Ian Denny, A&E Industry Expert

Part 4 in a 4 part blog series by industry expert, Ian Denny.  The operating budget of an Architecture and Engineering firm is a dynamic, ever-changing organism with many interconnected pieces…

 Putting the pieces back together

In the first installment, we created an overview of an integrated budgeting process for architects and engineers.  In part two, we delved into making a rough sketch of what an architecture or engineering firm budgets should look like.  And, in part three, we addressed one of the most critical budgeting aspects - architecture and engineering project budgets. 

Finally, now that we’ve parsed all this data and created a plan on each project, we need to digest it to see what the impact will be on the firm’s overall budget and forecast.

How to interpret a Project Workload report

The most powerful way to predict the revenue you will earn for your effort on projects is a project workload report. A good one will take all these plans you’ve set forth, based on your dates, and phases, and factored percentages on proposal opportunities, spreading out this projection over the life of the project.

What you can predict with an integrated workload report is: labor revenue for future periods based on project plans and completed work, number of hours required of your staff, and the estimated direct salary costs for that effort.

These key values can then be compared to your company budget and you can determine, if there is a gap, what needs to be done. Do we have enough work under contract to fulfill our budget goals? What if our proposals come in according to projections? And how does the projected direct labor cost from the workload compare to our initial estimate of direct salaries in the budget? Does this represent adequate utilization of staff time?

How to estimate direct and indirect labor costs

Specifically, we can take the estimated costs from the workload report and interpret them as our estimate of direct labor costs. There are then two different approaches you might take to budgeting the indirect portion of labor costs.

(1)  Take the total direct labor costs from the workload report, and subtract them from your projected gross wages for the period based on current staffing levels. The remainder is your projected indirect labor. Then take the ratio of direct labor to total labor, and this is your projected utilization based on current staffing

(2)  Take the total direct labor costs from the workload report and divide it by your desired utilization percentage to arrive at a desirable level of total gross wages, or in essence, an ideal staffing level. For example, if you expect your firm’s total labor costs to be 60% billable, and your workload projects $100,000 of direct labor, estimate that 100,000/.6 = 166,666, and compare that to your current projected gross wages. Do we need to cut or add staff to keep that utilization?

Understanding the impact of your billing practices on your budgeting process

Many firms already use a best-practice billing method without even fully realizing it. That intuitive idea pertains to the Billing Cutoff Date. It is most accurate to recognize your billed revenue on the cutoff date of the invoice. Meaning if it’s July 10 today, but we’re billing for June time, we recognize the revenue on June 30. This approach will keep your workload report working in your favor, because it projects earned revenue based on the period of the work performed.

Secondly, and this is trickier, whenever possible it is best not to bill dollars ahead of the work performed. This can jeopardize the usefulness of workload-based forecasting, because the work still needs to be performed, but the revenue has already been booked. When we do need to bill ahead, accounting entries can be made to essentially defer the revenue to the correct period we expect to actually earn it in. This keeps your budget whole.

Understanding the impact of earned value analysis on your budgeting process

Earned value analysis is a powerful project management tool encouraged by PSMJ. Essentially, what it means is that we want to compare planned completion, to actual completion (earned value), to effort expended (“Spent” or “Earned” based on billing rates).

Earned value analysis can be used strictly as a way for project managers to see whether their projects are on-track or not, but it can also be used as a method for accrual-based revenue recognition.

If your firm does use EVA as a revenue recognition method, you will need to consider this when budgeting and re-budgeting. It poses a similar challenge to the bill-ahead situation when trying to predict revenue based on the workload. For example, based on the workload report we may expect $10,000 of billable effort in a period on Job A, but if we have already “delivered” $15,000 worth of effort and recognized that as revenue, we would need to adjust our forecast accordingly. Similarly, the workload could indicate that only $5,000 of work is left under our contract value, but if we’ve only delivered $5,000 worth of results, we may need to recognize more revenue later in the job.

Even with these nuances, workload-based reporting is a potent mechanism for understanding whether or not you will meet your goals, and an essential tool in managing your staffing levels.

The Bottom Line: Your Projects Are Your Business

At the end of the day, what this is all about is this: The bread and butter of your business is the projects you execute for your clients. You already know you must manage your projects successfully to manage your business successfully. What do you have to gain? Unlimited access to data you already manage on your projects in a way that can help you predict the viability of your firm in the near and medium term, and the ability to compare that picture to your goals.

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