Recent news that a well-respected Scottish Architects’ practice has failed due to cash flow emphasises the importance of robust financial forecasting. Surprisingly, on average, only 50% of the architectural practices we meet maintain monthly cash flow models. Alex Shall, Partner at Haines Watts London, discusses why it’s so important for professional practices, and details his tried and tested three-model method.
A typical design project for an architectural practice lasts between 9-24 months. I normally ask my clients to maintain a two year fee pipeline. But what is the best way to model cash flow and profitability and why is it so important for owners to review regularly?
There are multiple benefits attributed to maintaining a dynamic financial forecast model.
In the first instance, you’re going to ascertain whether or not your practice will be profitable over the next 12 months. Secondly, you will test whether you have sufficient working capital to actually deliver the work you have.
But beyond that, the forecast is a valuable source of information for measuring the direction of your business, the kind of work you will do over the next two years and how you might need to shape your team to deliver it.
I encourage my clients to build 3 cash flow models, looking at the worst case, midpoint and best case scenarios.
This is the model I build first. It lists what you will bill and collect over the coming 2 years. It is important to be realistic about payment dates from clients, considering how long they typically take after the invoice date.
The worst-case model is used for assessing basic profitability and cash flow to ensure the business can operate over the next 12 months and that enough profits are being generated to provide a basic draw for the owners. It can offer crucial warning signs on when costs need to be cut or more work is urgently needed.
This includes everything from the worst case model, with the addition of any expected variations or prolongations in projects, and where you are more likely than not to get additional fees from clients.
This mid-point model is used as a business planning tool and a working forecast. This forecast helps you to understand whether you’re going to have enough cash reserves to help you invest in resources to fuel growth, e.g. staff, internal systems, marketing. This is also the model that shows you the most expected resource requirement, and so ought to drive your decisions on staffing matters.
The best case model incorporates the models above plus any work that the practice feels confident they will win. This could be projects you have bid for and think you will get as well as other work promised to by clients that you think will materialise.
This forecast is used for long-term planning. In particular, understanding the makeup of the type of projects that your practice is working on. Questions can be asked at this level as to whether that work is in alignment with the brand and the work the directors want to undertake.
Effective financial modelling is essential to the longevity of any business. But a model is only as good as the information available and it must be kept up to date at least monthly with the inevitable changes in circumstances.
These 3 models will give you, the owner, 3 different perspectives on your business and allow you to plan accordingly.
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