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How Much Profit?

Dear Dave
We’ve read articles and surveys stating the typical consulting engineering firm makes a profit of somewhere between 5 and 10%. Our firm makes considerably more than that. Are we really that good, or are we misunderstanding these reports? Our firm does commercial and residential site engineering and surveying. We have a total staff of approximately 40.

Dear KH
Perhaps both. A 1999 design firm financial performance survey conducted by Birnberg & Associates and released by Axium, an A/E firm financial management software company, found that the 78 engineering and architectural firms participating in the 1999 survey reported average profits, before taxes and discretionary distributions, equal to about 10% of total revenues.

Comparing profits between firms presents the same problem as when trying to compare overhead rates (see Q&A in CENEWS April 1999). No two firms do things the same way making it next to impossible for a straight-up comparison of bottom lines. If Firm A provides a rich and generous benefits package for its staff and shows less profit than Firm B, which provides modest benefits, is Firm B really more profitable than Firm A?

Rather than getting caught up too much with what you hear or read about others, here is a self-test of profitability I would recommend.

If when reaching the end of any year using the accrual method of accounting, after covering all of the expenses you are obligated to pay from month to month, you don’t have the equivalent of at least 15% of gross revenues left over for discretionary pension or profit-sharing contributions, staff and principal bonuses, and retained earnings to be reinvested back into the company, your firm is not earning enough.

Strong profits are crucial for any firm in order to remain healthy. Never be apologetic about managing your firm for profitability. You need to be making enough profit to ensure a consistent and adequate stream of cash flow is present to meet regular obligations in a timely fashion without forever running to your bank. Profits must be on hand to provide for significant compensation incentives, and to reinvest in facilities, equipment and training to keep your company evolving in step with (or preferably even ahead of) your clients and your competition. Without adequate profits, none of this can possibly occur.

Okay, so you find you are regularly getting to the end of the year without at least 15% of gross revenues in reserve; what do you do about it? Simple: increase revenue and/or lower cost until you do have at least 15% of gross revenues left over.

On the revenue side, raise your fees or change the methods you use to contract for your services. Maybe you would be better off with more time and material type agreements, or perhaps an analysis might show you could improve profitability with more fixed fees or lump sum contracts. Change clients; there are lots of them out there. Perhaps it is time to finally take an objective, hard look at some of your longtime relationships. Are they too good for the clients, but too bad for you? Are there opportunities to add new services to your firm that have the potential to generate greater profit margins? At the same time, should you stop offering those services that fall short on profitability and have no realistic chance for improvement?

If you cannot make enough enhancements to the revenue end of the equation alone, go to work on the expenses. Start with principal salaries. If you’re not ending the year with a 15% reserve, perhaps principal base salaries are too high relative to performance and need to be cut. Are there other salaries or fixed expenses that can be reduced or eliminated to help contribute to an adequate year-end profit pool? If you’ve really already cut all you can, and determine you cannot possibly cut salaries and expenses any more, and you’re still not generating 15% or more, you need to go back to work in renewed earnest on the revenue end. Recognize there is a fundamental mismatch in your practice that needs to be addressed. Either your costs are too high, or the revenue potential from the work you do is too low for the kind of operation you wish to run. Fix it.

Every firm has an occasional bad year, but a failure to address consistently insufficient profit levels is a guarantee of future misery. Among other things, you’ll be perpetually stressed over scratching together cash to cover expenses. Good people will leave because they can make more and have greater opportunities for professional development and advancement elsewhere. You will fall further and further behind more profitable firms who are investing to improve their technological and service capabilities. Conditions such as these, if allowed to persist, will prevent your firm from ever reaching sustained, adequate levels of profitability.

Be passionate about profits, it is the key to a successful future.

Wahby and Associates