Three ways to build AEC firm value

In order to increase the value of architecture, engineering, and consulting (AEC) firms need to make actionable management decisions, focus on gross profit, and reduce the average collection period (ACP).

By Neil Churman, 7 Mile April 26, 2018

7 Mile Advisors recently had the opportunity to sponsor and participate in the AEC Profitability Summit in beautiful Miami Beach. The event, hosted by AEC Business Solutions, focused on “finding the lost dollars” in architecture, engineering, and environmental consulting businesses. Attendees looked for ways to improve profitability across a range of areas spanning project management to sales and marketing to resource management. Building on the summit’s emphasis on improving profitability, here are three simple ways that AEC firms can not only improve their profitability, but can enhance the long-term value of their firms.

1. Get Serious About Metrics

As designers, project managers, and problem solvers, AEC professionals love data. Most firms do a great job of tracking a variety of metrics. In our experience though, using those metrics to make actionable management decisions is an area in which most firms could improve. “People businesses” like AEC firms tend to be “quick to hire and slow to fire” when in reality, they should be the other way around. Firms that look to a reliable set of metrics as a guide to management decision-making often make better decisions faster.

If you had to pick just one, we suggest tracking revenue factor — that is the ratio of net service revenue to total labor expense. Many firms track utilization and direct labor multiplier, but revenue factor combines the two. It takes any “gaming” among employees out of utilization and multiplier targets. Revenue factor asks “How many dollars of net revenue can I generate for each dollar I spend on labor?” The higher the revenue factor, almost invariably, the higher the bottom line profitability and the higher the value for an AEC business.

2. Focus on Gross Profit

AEC Industry Firms’ Reported Gross Profit Levels as of March 2018

Firms that are able enhance their gross profit, tend to be more highly valued. Gross profit measures total revenues, less cost of sales. For most AEC firms, cost of sales means subconsultant/subcontractor expenses, direct expenses like travel, prints, and equipment, and direct labor expenses. Firms that can push gross margin higher afford themselves the opportunity to grow their businesses more sustainability. We often see firms that try to boost the bottom line by simply “running lean” or cutting overhead, but this is often at the expense of building infrastructure (like reporting systems, marketing teams, HR, IT, etc.) that provide the backbone for the firm to scale. If the firm’s gross profit is weak, there is often fundamental weakness in the business that no amount of cost cutting can repair. Firms that can focus on enhancing gross profit will build more long-term value than those that simply look to hold overhead down at the expense of building the business “the right way.” See 7MA’s latest Sectorwatch industry research report for more on industry gross profit levels.

3. Get Paid

Another common significant area of improvement for AEC firms is in reducing the amount of time it takes the firm to collect its accounts receivable (“AR”). Often referred to as Days Sales Outstanding (“DSO”) or Average Collection Period (“ACP”), this metric calculates the length of time from an invoice being sent to the time the cash is collected. Firms that can collect faster will have less working capital “tied up” in AR — that is, essentially financing your customers’ operations. Beyond just collecting faster, many firms can make headway by simply billing faster. Firms that can move from monthly billing to continuous billing (i.e. sending an invoice as soon as contractually able to do so), can even further reduce the amount of time from doing the work to collecting the cash. AEC firms that can reign in DSO and collections will make their firms more valuable in the long run.

Neil Churman is Director at 7 Mile Advisors. This article originally appeared on 7 Mile Advisors blog. 7 Mile Advisors is a CFE Media Content Partner.

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