Financial Management and Shareholder Value

0By David Cohen

0If your car isn’t running right you call a mechanic, but what if your company breaks down? By inspecting key performance metrics that determine profitability and impact shareholder value you can steer your company to success. As a professional service firm, your success is driven by effective project management—which is driven by time and efficiency of labor and value pricing. This is the "rocket science" needed to understand how to connect the dots from day-to-day operations to building shareholder value and opportunity within your design firms. As Judith Salvi, Principal, Finance and Administration at Prellwitz Chilinski Associates (Cambridge, MA) explained, “It always goes back to project management and when our staff starts taking on the ownership aspect of the projects—as they begin to review the contract, scope, and fee and how and when they disseminate this information to the team, and then connecting all this to the design and the clients’ objectives. When people stop paying attention to the intricacies of project management, things can get off track very quickly.”

0From a shareholder value perspective, the project management measures that track labor utilization, pricing, and project management efficiency are the component parts that drive the base earnings levels on which design firm value is derived. For a project oriented professional service firm the ratio of billable time to total time is of upmost importance. Affective management of this metric, known in the industry as utilization or chargeability, is a key component of profitability and driving shareholder value for your firm. It is an indicator of staffing adequacy on the professional and administrative sides of the firm, as well as the composition of staff from principal to project architect and from CFO to administrative assistant. As a result of the Great Recession, we have witnessed a declining trend in firm wide utilization rates to well below historic levels making it increasingly more difficult for firms to remain profitable. A primary reason for this decline is management retaining, or carrying, staff too long in hopes of an uptick in revenue. Recently, we have seen more managers become proactive in addressing overstaffing issues through reductions in force to match staff levels to revenue given the prolonged period of economic uncertainty. Tracking utilization can provide powerful project management insights, but other metrics need to be considered as utilization can be manipulated by employees who do not accurately record billable time on their time sheets.

0Therefore, along with utilization, it is important to track the net direct labor multiplier, which is defined as net service revenue divided by direct labor and has an inverse relationship to chargeability. This measures project staff efficiency and the firm’s ability to achieve premium, or value, pricing. One way to achieve premium pricing is through specific differentiation from your competition. To be meaningful, like utilization, this metric requires employees to accurately record time on timesheets. This metric is also subject to manipulation. For instance, when a senior level person elects to not record their time on a project for fear of “blowing the budget”, the project appears more profitable. I can not stress enough how important the accurate recording of project time is to understanding the direct costs and opportunity costs associated with any given project and curing low profitability. Another key element of staff efficiency is the net payroll multiplier or revenue factor, defined as net service revenue divided by total labor. Instead of only focusing on project staff, this metric measures firm wide efficiency inclusive of the administrative and support staff—there is no place to hide.

0The last performance metric on which this article will focus on is the firm’s overhead rate, which is the ratio of overhead expenses (including indirect labor and all other selling, general and administrative expenses, excluding incentive bonus payments) to direct labor. For every dollar spent on billable labor, the overhead rate measures what is being spent on support costs. Again there is an inverse relationship to chargeability given that labor is a design firm’s largest cost. As the industry utilization decreased through the economic downturn, so increased the overhead rate; however, overhead rates have begun to decline to more normal levels. Firms with multiple offices, locations in high-end cities, ineffective marketing costs, too many administrative or overhead personnel, or unproductive senior staff “dead wood” will tend to have higher overhead rates and lower profitability. In my experience, the easiest way to control overhead is through labor force adjustments.

0A dashboard level of review of these performance ratios combined with a balance sheet snapshot of your firm’s financial condition including the current ratio, working capital, average collection period, and financial leverage/firm capitalization will connect the dots between project management and building shareholder value. This type of compilation should allow you to avoid analysis paralysis while utilizing these key elements through open book management to drive value in your design firm.

About the Author: David Cohen is a Managing Director with Matheson Financial Advisors, and he specializes in business valuations, ownership transition planning, and mergers and acquisitions as part of exit strategies and strategic plans. He also conducts seminars on these financial management topics for design industry organizations, as well as leading in-house educational presentations for firms nationwide. David can be reached at dcohen@mathesonadvisors.com or 508-655-9700.

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