How to set a budget (without losing your mind)

If you’re like most other principals and managers of consulting engineering firms, you’ve either just been through, or are in the middle of, your budgeting season. While you’ve probably searched for the simplest and most accurate budgeting procedure, there is no universally accepted or applied budgeting process in the consulting engineering industry.

Indeed, given the highly fragmented nature of our industry, what works for one firm may not work or may not be appropriate for another.

At many smaller or first-generation firms, management teams either don’t see the need or don’t have the time to establish an annual budget.

For that matter, it’s not surprising to find many firms between $10 and $30 million who don’t have an operating budget. Multi-office, multidepartment firms face unique budgeting challenges—particularly in the assignment of overhead across their regional and operating units. In fact, allocation of overhead often becomes a flashpoint between firm managers for the manifestation of lingering resentments about "corporate." But we’re engineers. We know we need a budget; yet often we don’t know where to start or where we’re going. So, if you’re struggling with developing your budget for 2005, or if your current process feels like being trapped in one of the concentric rings of Dante’s inferno, here’s a budgeting process to consider that’s simple, robust, and scalable.

Step 1: Budget firm-wide net service revenues. Net service revenues are defined as the dollar volume of fees received by the firm—excluding fees that are passed through to sub-consultants and reimbursements from clients for expenses. Budgeting your net service revenues requires an understanding of your backlog, the current opportunities your firm is pursuing, the market environment you’re operating in, the strength of your marketing and business development efforts, and your team’s ability to capitalize on the opportunities presented by the external environment.

In an ideal world, the best way to do this would be to get input from all of your business unit managers and build your revenue budget from the bottom up. However, business unit managers are notorious for being either consistently optimistic or pessimistic about the future (some also are known for not even thinking beyond the current month). That’s why senior management needs to be involved in the revenue forecasting, so that the revenue budgets are as realistic as possible.

Establishing an accurate revenue forecast is the key to having a workable budget. For firms that are budgeting for the first time, this is often a complete crapshoot because they may not have the forecasting tools or experience to put this in place. If you’re a budget first-timer, rest assured it gets easier going forward, and you will get better at it. Again, reality is key, so be sure to drive out any false optimism or institutional pessimism from the process.

Step 2: Budget direct labor expenses. Do this by determining the firm-wide net labor multiplier—calculated by dividing net service revenue by direct labor dollars. Your multiplier is determined by (a) how efficient you are at executing fixed-fee projects, and (b) how much you can charge for your services. You can drive your firm-wide multiplier up by improving your performance on projects and by enhancing your perceived value in the marketplace through smart marketing, sales, and execution. Conversely, you will see your multiplier erode by continuing to have inept individuals manage projects, by not investing in project management training and development, and by ignoring your potential clients. It’s your choice. Multiplying your revenue budget by your projected multiplier yields firm-wide direct raw labor expenses.

Step 3: Budget total raw labor expenses. Determine what firm-wide utilization you will achieve next year—defined as the percentage of total raw staff labor dollars (not hours) charged to projects. Dividing budgeted direct labor expenses by this percentage yields total raw labor expenses.

Keep in mind that you and your management team have greater firmwide control of utilization than of the labor multiplier. Your multiplier is determined in considerable part by the external competitive environment, whereas utilization rate can be controlled by how and when you make adjustments to staffing levels. To establish the most accurate budget possible, it’s critically important to establish realistic forecasts for your firm-wide multiplier and utilization rates. Understanding your firm’s historical multiplier and utilization performance will go a long way toward allowing you to set an accurate combination of these two vital indicators. Also, be sure to get as much relevant benchmarking information as possible so that you can see how your historical and anticipated multiplier and utilization rates compare with those of your peers. Such comparisons provide another reality check in establishing a workable budget.

Step 4: Determine burdened labor expenses. This involves burdening your raw labor expenses with fringe benefits and payroll taxes. For most consulting engineering firms, total burdened labor expenses range between 117 percent and 121 percent of unburdened raw labor dollars.

Step 5: Determine non-labor expenses. This involves an understanding of all of your non-labor dollars. Remember that non-labor expenses will not necessarily correlate linearly with either projected labor or revenue trends. The best way to budget this line item is to understand the firm’s current non-labor expense levels and then layer on all of the non-labor investments and expenses that will be required to achieve the revenue, utilization, and multiplier performance for the upcoming year.

Step 6: Determine profit. Adding the results of Step 4 and Step 5 yields total expenses for the year. Subtracting that from Step 1 yields pre-tax, predistribution profit for the year. Isn’t this what budgeting is all about?

Setting up a spreadsheet to model this budgeting process is easy. Once it’s created, you can plug in different revenue, multiplier, utilization, burdening, and non-labor elements and run a variety of budgeting scenarios.

This tool will show clearly that bottom line performance is tied intimately to revenues, multiplier, and utilization. The more control you have over these three items, the greater rewards there will be for you, the rest of your management team, and your staff in 2005. Good luck!

Mick Morrissey is a former senior vice president with ZweigWhite Consulting.

Posted in Uncategorized | January 29th, 2014 by

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