Principals' Salaries

Dear Dave
My two partners and I disagree on the relationship between salary and billable hourly rates. We pay ourselves a salary which, according to reports we read, is way below average because my two partners are afraid of having resulting principal billing rates that are perceived as too high. We bill out principal time at $80 per hour. Our company overhead factor on direct labor is about 120% and we target a profit of 15% on top of that bringing our billing multiplier to about 2.50. We then divide our $80 per hour principal billing rate (what we think is market acceptable) by 2.50 which sets our annual salary at about $66,000.

My partners’ position is that the billing rates we charge must fully cover salary, overhead and profit for accounting purposes. Our overall partner compensation for the entire year is more than adequate because we typically have been able to consistently pay ourselves substantial year-end bonuses that more than make up for the low salaries during the year.

According to this year’s CE News survey, the average salary for engineers with our level of experience is about $88,000. Why can’t we pay ourselves this much in salary (or some other number we agree on) regardless of the hourly rate we bill out at? Most of our work is lump sum anyway.
CF PA

Dear CF
You can. I see no reason why your salary has to be capped based on working backwards from the $80 per hour billing rate you charge out for principals.

It’s quite common at firms for the hourly billing multiplier used for principals (and other highly paid individuals) to be lower than the multiplier applied to the hourly rates of lesser paid individuals in the organization. They need not be all the same. The key is to attain a top-to-bottom, across-the-board average multiplier that is sufficient to cover cost and produce a desired level of profit.

Your conservative salaries do have the benefit of conserving cash flow during the course of the year, and do insulate the firm should business fall off by not having to deal with higher fixed salaries, but you don’t want to be so conservative that you feel personally deprived. Try to work with your partners to find a level of comfort you can all agree on.

Finally, your $80 per hourly principal billing rate and 2.50 billing multiplier strike me as being quite low. You might want to do a little research in your local area market to see if perhaps there may be an opportunity to gradually and selectively begin to work your billing rates up in the future.