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Why Oversimplifying A/E Firm Accounting Hurts Results
September 30, 2020
How architecture and engineering (A/E) firms recognize revenue has a significant impact on their success. Unfortunately, many software packages give firms options on how to manage this critical function, and some of those options aren’t helpful! Often, these packages provide a “simplified” way to record revenue, but taking the easy route can lead to problems down the road.
Accounting is More than an Overhead Function
Many of the firms we work with will say, “Why invest in improving the way we do accounting, when it’s just overhead and not a revenue-generating function? Isn’t ensuring we’re accurate for tax purposes by looking at the profit and loss information out of QuickBooks enough?” The answer, from our experience, is that if all you’re looking to do is meet the minimum standards in your accounting, you’re missing out on great ways to improve your operations and increase your profitability.
Any accounting system can handle debits and credits. Allocating costs to projects, on the other hand, is the central role of any software system designed to help an A/E firm thrive. Job cost accounting is critical to a firm’s success. The data it provides is used to support operational decision making about things like which clients are most profitable, which project managers (PMs) are doing the best job of budgeting based on the scope of work and sticking to that budget, etc. You can’t get this kind of “intel” from a simple general ledger system.
Beyond Job Cost Accounting
Job costing isn’t the only challenge, of course. Firm owners and accountants understand that every time an architect or engineer posts an hour on their timesheet, two things have occurred. First, the firm has incurred an hour of cost, and applying that cost to the right project is key. Second, the firm should have generated one hour of revenue, provided that that hour falls within the parameters of the contract.
These hours accumulate over the course of a month and then get invoiced, but the revenue hour and the cost hour have to stay connected in the same period of time. If they don’t, all the leverage they could have provided in helping the firm operate more effectively is lost. Some software packages give you the option of not recognizing revenue until you generate an invoice. This “dumbing down” of cost/revenue tracking breaks that connection. And because many critical A/E metrics depend on both cost and revenue, the firm is essentially blindfolded to a degree.
For example, the labor multiplier requires the labor cost and the revenue so that you can determine if you have the desired 3X relationship. If the cost and revenue are separated into different accounting periods, you’re not calculating an accurate multiplier. Plus, that multiplier is used elsewhere, like in revenue factor, revenue-per-person, etc. all of which are now rendered useless.
Unfortunately, many firms let a significant amount of revenue be carried over into the following month. This means it gets compared to current-month expenses as opposed to expenses from the previous month. Ultimately, in terms of the data you need for decision making, this approach becomes a “junk in, junk out” scenario.
"The firms we work with find that not being allowed to take the path of least resistance forces them to do a little extra work, but the payoff is worth it."
Helpful “Restrictions” that Produce More Valuable Data
The firms we work with find that not being allowed to take the path of least resistance forces them to do a little extra work, but the payoff is worth it. Factor AE is a system that doesn’t give you self-destructive options. Revenue goes into the system the moment timesheets are posted.
This does produce a challenge on the accounting side to have a “budget reconciliation” system for understanding what revenue from the prior period can and should carry over as billable. In other words, it’s authorized, not out of scope, etc. But, with that system in place, you prevent situations where work-in-progress (WIP) gets carried forward for many months. We see firms with unreconciled WIP for as long as a year, which gives management an inaccurate representation of their profitability if the WIP is ultimately written off.
The workaround that many firms use is to assess their costs against a cost budget only. But because the revenue isn’t associated, that’s all the further the cost accounting can go. And trying to get back to the data needed to see a clear picture at some point down the road is actually more difficult than just writing the WIP up or down each month. Factor AE empowers PMs to track net fee multiplier using both costs and revenue, and therefore gives them a more accurate representation of performance and how their work is impacting it.
Ultimately, we’ve found that the firms that thrive have a revenue recognition system and also use earned value analysis (EVA). These tools take the subjectivity out of how to assess whether revenue can be carried over or must be written off.
In short: Better Job Cost Accounting = Better Operations.
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