9 min read
July 24th, 2024
Financial reporting in any business can be complicated; financial reporting in architecture firms, however, is even more challenging. Why does architecture firm financial reporting pose a unique challenge?
Key Takeaways
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There are two main reasons. The first is that businesses in the AEC industry are subject to their own set of financial reporting rules, regulations, and standards that do not apply to businesses in other industries. This means architecture firms must maintain a unique standard of back-office systems, data collection, and financial reporting. This can make it difficult to find good advice and instruction regarding how to establish and maintain an architecture firm's compliance policies and procedures.
The second reason is that an architecture firm's finances can be notoriously difficult to manage due to the myriad factors that impact business such as demand, workflow, productivity, staffing, costs, projects, the economy, and more. Since so many different moving parts impact financial management in an architecture firm, it's essential to have sound financial policies, procedures, and systems in place to facilitate accurate, timely, and reliable financial reporting.
What Are the Industry-Specific Financial Reporting Challenges for Architecture Firms?
ASC 606, IFRS 15, and Revenue Recognition
Many businesses are subject to the rules and recommendations put forth by the Financial Accounting Standards Board's (FASB) generally accepted accounting principles (GAAP). GAAP regulates the way businesses must handle costs, revenue, and reporting in their bookkeeping and accounting systems. It outlines how costs must be recorded, how revenue is recognized (realized and earned), and how a business's finances must be reported using standard financial reports.
GAAP for architecture firms, however, is slightly different because businesses that generate revenue as a result of contracts with clients are subject to additional regulations regarding revenue recognition:
- The FASB's Accounting Standards Codification 606 (ASC 606)
- The International Financial Reporting Standards Foundation's IFRS 15
These rules establish principles and processes for reporting and recognizing revenue that might be uncertain regarding the amount received and the timing when it will be paid. The regulations set forth standards that architecture firms must follow when reporting and recognizing their revenue. They detail when revenue should be recognized and reported (i.e. when a contract is agreed upon vs. when performance obligations are met vs. when payment is received) and the steps that businesses must take to compliantly deal with revenue recognition.
As a result of these regulations, architecture firms are subject to a detailed five-step process for revenue recognition that includes:
- Identifying a contract with a customer
- Defining the performance obligations within the contract
- Determining the price of the transaction
- Allocating the price of the transaction to the performance obligations within the contract
- Recognizing revenue as (or when) the business satisfies each of the performance obligations
For architecture firms, recognizing revenue properly is its own complex, multi-step process within the business's larger financial reporting responsibilities. Revenue recognition alone requires a significant amount of time, attention, and organization for proper management that ensures the right amount of revenue is recorded within the right financial period.
Read More: Financial Reports for Mid-Market Companies
Projecting Revenue
A revenue projection is the amount of revenue you anticipate your firm will generate within a specific future time period. As a rule of thumb, architecture firms should look at monthly, quarterly, and annual revenue projections. In an architecture firm, revenue projections are fairly complex because an overall revenue projection contains several categories that vary in terms of timing and certainty.
The categories within your revenue projections include your:
- Backlog - Existing, approved projects that you are actively working to complete. This projected revenue is almost 100% a sure thing. You know when you'll complete the projects and have a pretty good idea of when you'll get paid.
- Outstanding Proposals - Project proposals that have not yet been accepted by clients. This projected revenue is not yet certain and the timing of it potentially being received is also unclear. If you know your firm's conversion rate (proposals to accepted contracts), you can use that metric to estimate how much revenue to project out of your total proposals.
- Unidentified Future Projects - Clients you are attempting to attract or projects you are planning to seek. This portion of your revenue projection is the least certain in terms of amount and timing. It is more difficult to forecast because the category depends on several variables such as your past performance, current advertising or other client capture efforts, the market, and the economy.
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Maintaining Staffing Needs
In addition to being difficult to calculate and time, revenue projection trends are also intricately tied to your firm's staffing needs. If you have an upward trend in projected revenue, you need to assess whether or not you have enough staff to handle the growing demand for your services. If your projected revenue is trending downward, you need to determine whether or not you will still have enough cash flow to cover the costs of your current workforce.
So, to maintain proper staff to meet the firm's workload and maintain productivity, you'll need to nail down your projections, making the numbers as certain as possible so that you can time your hires or layoffs properly to avoid issues with capacity and utilization.
In addition to considering the firm's workload, also keep in mind the costs of turnover, the difficulty of retention, and the challenge of hiring talented staff in the architecture industry before deciding to cut staff. Finding talent and filling open positions continues to be one of the leading challenges faced by architecture firms, according to the American Institute of Architects.
So, if you can afford to maintain your highly skilled team and you anticipate that your shrinking revenue projections will soon turn around, you might consider cutting costs in other areas before slashing your labor category.
Cash Flow Statement Analysis in Architecture Businesses
Cash flow is the lifeblood of your firm, and a cash flow statement shows the timing of all of the money flowing into and out of the business.
Healthy cash flow is positive (i.e. more money flowing into than out of the business at a given time). Positive cash flow means you're financially able to keep your firm operating as planned. A healthy cash flow enables you to purchase the supplies and tools you need when you need them and cover the rest of your overhead costs in addition to keeping your staff happily receiving their paychecks on time.
On the other side of the coin, cash flow shortages (negative cash flow where more money is flowing out of than into the business at any given time) have the power to put your firm out of business fast.
Like the other items on this list, cash flow analysis in an architecture firm can be challenging due to complex payment timing and the gap that can occur between recognizing and receiving revenue. Since the revenue that has been recorded on your books might not have been received from your client, there can always be a major discrepancy between your company's cash flow and income statements. In other words, your income statement can reflect revenue that does not yet exist in your bank account.
Maintaining a healthy cash flow and avoiding shortages means keeping a close eye on your firm's cash flow statements. You should also actively forecast cash flow to help anticipate and avoid shortages. This can also help to improve your budgeting plan so that your cash flow can accommodate the firm's spending.
For better cash flow, be sure to keep a close eye on your days sales outstanding (DSO) metric and focus on accounts receivable management to ensure you're receiving payment from your clients in a timely manner.
Read More: Top Cash Flow Tips for Architecture Firms
Keeping up With Project Accounting Standards
In project-based businesses, like accounting firms, two different accounting standards should be in place: project accounting and general accounting. General accounting focuses on the performance of the business as a whole, but project accounting looks at each individual project's performance.
Project-based accounting helps ensure the financial success of each project, adding up to the overall success of the firm as a whole. It can also help you better evaluate the kinds of projects and clients that are truly profitable for your business and the kinds of projects and clients that end up costing you money in the long run. This type of accounting provides you with the information you need to decide where your firm should focus its resources, efforts, time, and marketing dollars to generate the best ROI.
Project accounting standards are difficult to maintain because they require meticulous expense tracking, time tracking, and overhead expense allocation - and these things all require a high-powered back office equipped with smart automation tools.
Design a Back Office for Perfect Compliance and Management With Outsourced Accounting for Architecture Firms
Given the specifics and unique nature of architecture firm financial reporting, it can be extraordinarily difficult for an architect leading an architecture firm to balance the core functions of their business and leadership responsibilities with the demands of back-office tasks. Plus, the labor of knowing, understanding, and keeping up with all of the changing accounting rules and regulations to which architecture firms are subject is a full-time job and requires an advanced degree of its own.
However, it is possible to meet and exceed the financial reporting requirements of architecture businesses, not only maintaining compliance but also leveraging your back office to improve business leadership, management, and profits - all while staying focused on the core function of your business.
For growing small or medium-sized architecture firms, the best back-office solution is outsourcing. Outsourcing saves money because it is much less expensive than an in-house bookkeeping and accounting department. Plus, an outsourced back office functions better, is flexible and adaptable, and is designed specifically to meet your firm's unique reporting and management needs.
With an outsourced back office, you'll have the tools, team, and technology at your fingertips to automate the collection of data, improve expense categorization, meet all of your compliance requirements, and access the reports, metrics, and experienced professionals you need to make data-driven leadership decisions. With an outsourced back office, you shift the burden of compliance and open up a high-powered avenue for improving operational efficiencies and productivity while maximizing profits.