Improve your profits by understanding your costs

Having worked with ACEC now for four years as your President but as a non-engineer with no prior industry experience, I have been curious to understand how in an upbeat market where members seem to be very busy, the industry continues to struggle with poor profitability.

Many have said it is because our industry practices low-balling which reflects a lack of discipline and makes us our own worst enemy. The consequence is that our industry will become starved of capital, leading to lower salaries and reduced investment in equipment, R & D and training. This ultimately harms the interests of our clients.

But a study that is still in draft form and is being developed for the Consulting Engineers of New Brunswick suggests that our industry’s generally poor profitability may, at least in part, be because many of us don’t know what it costs to run our businesses and therefore don’t know how to price our services and when to say no to clients.

The study determines what a firm’s charge-out rate has to be if it is to earn a very modest 5% profit on net billings. The answer is 265% of salary based on an average salary of $40,000. The study reminds the reader that the 5% profit does not account for taxes or internal disbursements. And it leaves no room for major renovations/purchases, shareholder dividends or the capacity to save for future corporate mergers or acquisitions. A healthier profit target of 20% would require a charge out rate of 302% of salary.

The 1999 ACEC Business Survey of Members reported average salary multipliers within the industry for design services of 2.54.

Apply your own numbers and experience relative to that of the New Brunswick study as you read on.

In determining the firm’s charge out rate the study started by calculating salary and benefit costs based on an industry average of $40,000 per year. To that was added the following:

So total salary and benefit costs, not including time benefits of holidays and sick days, equate to 113% of salary based on a full year of service.

There are, of course, other costs to take in mind (unless your employees are working from home, using their own kitchen table, pens/paper and computer) and those costs are calculated in the table below.

Of course, we don’t work 260 days a year (5 days a week x 52 weeks) so deduct 15 vacation days, 10 statutory days and 4 sick days on average from your available time. In addition, employees are rarely if ever charged out 100% of the time. A more typical chargeable time for the company including office staff is closer to 65%, and based on this figure the firm must now charge clients 227% of salary if it is to break even.

However, this figure assumes that every chargeable hour can be billed –nice thought but improbable. As well, some projects may lose money, which has devastating effects on a group’s business performance. And not all time spent on bid preparation ends in the firm actually winning the job. Using 90% as a value for billability, the charge out rate becomes 252% of salary.

For a 5% profit on net billings before taxes and disbursements, your rate has to be 265%. You may have other expenses that will necessitate a higher rate, or you may operate differently and have lower costs than shown in the New Brunswick study.

One thing is for sure from the New Brunswick study — the technical skills of a firm’s employees are and will continue to be seen as an essential component in the firm’s business success. But, for a business to be profitable, it also needs to create a profit-oriented culture throughout the organization, and that can start with a clear understanding of the costs of doing business and how those costs can be better managed.