Finance and accounting terminology made simple
Many folks working in firms in the A/E/P and environmental consulting industry don’t understand commonly-used financial terminology. How can you blame them? If no one ever explained it to them you can’t expect them to know it.
It isn’t difficult, but not understanding it puts your people at a disadvantage and is bad for the firm. We want everyone who works in an A/E/P or environmental firm to understand this stuff. So here we go with some simple definitions of terms we all hear every day. Please pass these onto your people!
Gross revenue. All revenue from the operations of your business or business unit, including subconsultants and reimbursable expenses.
Net service revenue (NSR). This is gross revenue (see above) less subconsultants and reimbursable expenses.
Raw labor. This is the total labor cost in salaries and hourly wages and includes no company-paid payroll taxes or insurance or anything else. E.g., someone earning gross pay of $25 an hour and working 2,000 hours in the year has a raw labor cost of $50,000.
New project “sale” (or sales). The dollar value of a new project (or projects) under contract with authorization to proceed.
Backlog. The total amount of work under contract yet to be performed. This can be expressed as a dollar amount but it’s usually expressed in months. Calculated as total backlog divided by net service revenue times 365. E.g., a company with $5 million in NSR and a $3-million backlog has 219 days of backlog.
Direct labor. The dollar amount of raw labor charged to active jobs or projects.
Total labor. The dollar amount of total raw labor.
Utilization rate. Total direct labor dollars over total raw labor dollars. E.g., a firm has total direct labor of $2 million with total raw labor of $3 million. The utilization rate is 66.67 percent. Some people calculate this as total direct labor hours over total labor hours, but this is not correct!
Effective labor multiplier. Net service revenue divided by raw direct labor dollars. E.g., a firm has $5 mill in NSR with $2 mill in direct labor. Effective labor multiplier is 2.5.
Target labor multiplier. Projected net service revenue divided by projected raw direct labor. A hypothetical number that may or may not become reality.
Revenue factor. Net service revenue divided by total raw labor, OR utilization times effective labor multiplier. E.g., a firm with NSR of $5 million and total raw labor of $3 million has a revenue factor of 1.67.
Accounts receivable (AR). The total dollar amount of all bills sent out but as of yet owed to you by clients.
Average collection period (ACP). The time it takes you, on average, to collect on an invoice. Expressed as days outstanding. Total AR divided by annual gross revenue times 365. E.g., a company has a total AR of $1 million and does $6 million in gross revenue. ACP is 60.8 days.
Work in-progress or work in-process (WIP). This is the total value of work performed that has not yet been billed to clients. Usually expressed in days of unbilled revenue. Unbilled revenue divided by annual net service revenue times 365. E.g., a company does $5 million NSR and has total unbilled work of $350K. WIP is 25.5 days.
Overhead rate. Total costs less total direct labor divided by total direct labor. E.g., a company has $4.5 million in total costs with $2 million in direct labor. Overhead rate is $4.5 million minus $2 million divided by $2 million, or 1.25. Usually expressed as a percentage, this would be 125 percent.
Accounts payable. Total of all money you owe your subconsultants and suppliers.
Current assets. Cash in the bank plus accounts receivable on a specific date.
Current liabilities. Accounts payable, accrued payroll (money people have earned but not yet been paid), and other short-term obligations.
Current ratio. Total current assets divided by total current liabilities.
Income statement. Total income less total expenses equals profit or loss. Covers a period of time – usually a month, quarter, or year.
Balance sheet. Total assets minus total liabilities equals owners’ equity or “book value.” Calculated at a specific point in time – usually month end, quarter end, or year end. A “snapshot” view of the firm.
Accrual accounting. Revenue is based on revenue earned, whether or not it has been billed or collected, and expenses are based on expenses incurred, even if the company hasn’t received a bill for them yet.
Cash basis accounting. Revenue is based on money received by the firm (cash in) and expenses are bills that have been actually paid (cash out). Cash basis accounting is how one keeps their checkbook.
Mark Zweig is Zweig Group’s founder and CEO. Contact him at email@example.com.
This article is from issue 1155 of The Zweig Letter. Interested in more management advice every week from Mark Zweig, the Zweig Group team, and a talented list of other guest writers? Click here to subscribe for free.