The metrics by which we define our successes and failures within the finance function are vital to ensuring that it runs as effectively as possible. These 10 key performance indicators, as set out by Steve Winters of AIA, should be thoroughly understood so that they can be properly used.
The overhead rate is the metric used to assess the profitability of each product a firm is selling. In performance terms, it is the cost of expenditures that aren’t directly related to a project as a percentage of total direct labour. The lower the overhead rate, the higher the profit margin. A target of 150-175 percent of total direct labour is acceptable, while anything exceeding 175 percent should be a cause for concern.
The utilization rate measures the degree to which potential output levels are being met or used. It shows the percentage of hours spent on billable projects compared with the total number of hours worked. The goal of the entire staff should be to use between 60 and 65 percent of their time on billable projects. For professional and technical staff, it should be between 75 and 85 percent.
Net revenue per employee
The net revenue per employee is a useful metric for forecasting a realistic range for future annual net operating revenue. It is calculated by dividing the annual net operating revenue by the number of employees.
The net multiplier is a firm’s actual revenue as a percentage of total direct labour. For a firm to make a profit, this has to be higher than the break-even rate.
Aged accounts receivable
The average annual amount of unpaid invoices divided by net operating revenue/365 gets you to the average age of a firm’s accounts receivable. Any outstanding invoices not collected within 90 days should be a cause for concern, while the target should really be to collect all of them within 60.
Proposals pending is the amount that a firm has coming in the future compared with the firm’s budgeted annual net operating revenue. This is divided into two parts, prospects and suspects. Prospects are proposals that the firm has a 50% or better chance of winning, while suspects are those the firm has a less than 50% chance of winning. The total dollar amount of these should be 2.5 to 3 times net operating revenue.
The profit-to-earnings ratio measures how effectively a firm is at completing projects profitably. It is found by dividing the profit (before + distributions and taxes) by the net operating revenue.
Backlog volume is the unbilled dollar value of a firm’s current fee contracts. An effective finance function should aim to have a backlog volume that is at least equal to the firm’s budgeted annual net operating revenue, or else it could mean the firm is unable to meet demand, creating a backlog that could impact its earnings.
The break-even rate is the point at which revenue equals costs. All members of staff have their own break-even cost, which is found by adding the overhead rate to their hourly salary, represented by the unit of 1.0. If a firm’s overhead rate has an overhead rate of 1.5, the break-even rate for each employee is 2.5 x hourly salary, as 1.0 + 1.5 = 2.5. If the hourly salary is $10, this would be $25 an hour. By dividing this cost by the complement of a desired profit margin, you get the hourly billing rate.
Cash flow is the amount of money a firm has on hand. If a firm has inadequate cash flow levels, it may not be able to meet its financial obligations in a timely manner, and could fail to pay staff, vendors, and taxes. A monthly cash flow report and 12-month cash flow projection can help a firm plan ahead to mitigate swings in cash flow by accelerating collections, and a sensibly-used line of credit can also be useful.