From an economic standpoint, the architecture and engineering industry has been one of the hardest hit. We've seen firsthand how it has impacted our A&E clients—from having to make significant staff cuts to scrutinizing cash flow. It is particularly evident in this year's 2009 Architectural Study (see article below), which is available now. Because the statistics and metrics contained in this study are extremely useful tools for A&E firms, we wanted to make the study itself as useful as possible. That is why this year's study also features engaging commentary from experts in the legal, professional liability insurance, and employee benefits industries. We also included highlights from the A&E Advisor Roundtable held in June 2009, which addressed many of the current issues our clients are facing.
The 2009 Architectural Study may be specific to the A&E industry, but it demonstrates how DGC as a firm goes above and beyond to provide clients not just with exceptional service but with knowledge and insight. If you know any A&E firms that could benefit from our expertise, please encourage them to contact us.
 2009 Architectural Study Depicts a “Perfect Storm” Effect
By David Sullivan, CPA
In early 2008, most architectural firms were still riding a wave of unprecedented success that began in late 2004. By the end of the third quarter, however, the tide was beginning to turn. By year’s end, the average firm saw net fee and profit per direct hour plummet by almost 14% and 30%, respectively. The average A&E firm shed approximately 16% of its workforce by the end of 2008, as owners tried to adjust their staff levels to the decrease in work. This year’s 2009 Architectural Study depicts a “perfect storm” effect, in which economic factors have converged to impact the industry at very core levels.
Thirty prominent architectural firms in the Greater Boston region participated in the 2009 Architectural Study. By studying and comparing their financial and operational data, DGC is able to calculate averages for specific performance indicators, such as direct labor billing multiples, utilization rates, break even multiples, average hourly rates and profit per direct hour. These are considered “vital signs” of an architectural firm. This study illustrates that there are financial ratios and relationships which can be applied to any firm in order to benchmark performance and identify trends, as well as areas for opportunity and improvement.
Highlights of the 2009 Architectural Study include:
Utilization rate decreased to 60.4%
The utilization rate is widely regarded as the most influential statistic on firm profitability. The 2008 rate is the lowest in the past 5 years and well below the target rate of 64-66% typically needed to achieve sustainable levels of profitability.
The direct labor billing multiple increased to 3.20
The direct labor billing multiple is a measurement of project profitability. Initial results for 2009 indicate that the billing multiplier is decreasing significantly due to downward pressure on project pricing, overstaffing situations at many firms, and increased competition for fewer projects.
The average firm billing rate increased to $105.81 per direct hour
The 2008 average billing rate increased a modest 2% to $105.81, largely due to the increase in the direct labor billing multiplier. Early indications for 2009 reflect a downward trend in bill rates as firms contest for less work in an increasing competitive marketplace.
The breakeven multiple increased to 3.01 and the overhead rate per direct hour increased to $64.13
These overhead statistics measure the indirect costs of a firm. Both of these statistics are the highest they have been in the history of the study. They are heavily influenced by a firm’s utilization rate. It is clear that many firms found themselves overstaffed in the later part of 2008, which had a negative impact on utilization, pushing the overhead statistics upward.
Working capital levels were still strong at year end
The ratio of working capital to net fee increased from 17.7% in 2007 to 23.88% in 2008. Although some of this positive increase is due to a reduction in the average firm’s level of net fee income, it is a sign that many firms are well positioned to weather through this recession with adequate working capital to support their reduced business levels.
In addition to interpreting the data and putting it in context for firm management, the 2009 Architectural Study includes recommendations based on DGC’s industry expertise and financial insight. To summarize, recommendations in this year’s study include:
- Be vigilant collecting accounts receivable and performing cash flow forecasts
- Monitor financial trends
- Adhere to staff reduction best practices
- Stay focused on business development
- Review succession plans
- Start tax planning early for 2009
- Keep a close watch over project profitability and project management
The good news is that once the storm has run its course, there will certainly be continued demand for design services from businesses, institutions and individuals. Planning for recovery is both necessary and obtainable, but it will require proactive decision making and the ability to make changes quickly. Firms that are smart about their finances and stay capitalized will be in a better position to take advantage of new business when the upswing begins. Recovery may be slow, but endurance will be rewarded.
To learn more about the 2009 Architectural Study and how to purchase a copy, visit www.dgccpa.com.
Smart Loans Pay Back in Tax Advantages
By Sarah Wulf, CPA and Stephen Colella, CPA
Loans can be an excellent tax planning opportunity, especially in the current economic climate of extremely low interest rates, since it is a way to shift assets on a temporary basis to other individuals. In order to take advantage of these low interest rates, however, care must be given in how you structure the debt so as to avoid any unintended tax consequences.
Each month, the IRS issues an updated set of interest rates for term loans made during that month. These rates are based on the period that the term loan will be outstanding, and are the minimum rates that you should use if you are setting up a term loan with another individual. For loans initiated in August 2009, the applicable federal rates (AFRs) are as follows:
- Short-term (<3 years) 0.84%
- Mid-term (3-9 years) 2.87%
- Long-term (>9 years) 4.38%
The rates change every month, so you will want to find out the current rates whenever you decide to set up a new term loan. You may also choose to issue a demand note instead of a term loan. In a demand note scenario, you would use the blended average rate issued by the IRS each year to calculate interest for that given year. In each case, the interest rate must be at least the AFR, in order to avoid triggering the below-market loan rules or unintended gift tax implications. Interest should be due and payable at least annually, in order to avoid the so-called Original Issue Discount rules.
Regardless of which type of loan you set up or what interest rate you use, draft a written loan document detailing the terms of the loan. This is important in order to substantiate that the transaction was a legitimate loan between you and the other party (not a gift), and in the event the loan becomes uncollectible, you will have proper substantiation for a nonbusiness bad debt loss on your income tax return.
Planning tips to keep in mind if you are considering setting up a new loan:
- • When the other party uses the loan proceeds in order to purchase a principal residence, it is important that the note be legally secured by the residence so that the related interest will be deductible by the borrower as mortgage interest expense on his or her income tax return. For other borrowings, the deductibility of the interest on the loan for the borrower will be based on the use of the proceeds.
- There is an exception when all of the loans you make to a single individual total less than $10k, in which case you can pass on charging interest and not be subject to any gift taxes in doing so. In this case, the loan proceeds cannot be used by the other party to acquire investments or income-producing assets.
- Yourimputed interest income for income tax purposes will be zero if your total below-market loans to an individual are less than $100k as long as the individual to whom you loaned the money has annual investment income of less than $1k. then Your taxable imputed interest income will be limited to the borrower’s investment income, If such income exceeds $1k,. A loan to an adult child to acquire a residence when he/she does not have sufficient assets is a good example where this exception could apply. This rule does not avoid an imputed gift for gift tax purposes, if interest is not charged or is below the AFR . It also does not apply if one of the principal purposes of the interest arrangement was to avoid income taxes.
- By structuring the loan as a demand loan, as long as the actual or imputed interest on such loan (when aggregated with any other gifts you have made to the same individual) is less than $13k per year (or $26k if you elect to gift-split with your spouse), you will not have any adverse gift tax consequences if you choose not to charge or collect interest.
Please call your DGC team member to discuss these issues further before you structure a new loan so that we can discuss some of the specifics in greater detail with you.
Tips for Managing Professional Liability Risk
When work is scarce and revenue is declining, firms may begin to scrutinize their professional liability premiums as a means of saving money. This is certainly a viable option, but it is extremely important for management to understand the factors that affect coverage and rates before making any major changes. Here are a few tips to help manage professional liability risk.
 Utilize Claim Trends
Historical data is a good place to start, as it provides valuable information on which to base decisions. Comparing today’s claim trends with those from the 1980’s, the biggest difference is in residential projects. Residential claims from 1985-1996 were roughly 27% of all claims filed against architects, as reported by the CNA/Schinnerer professional liability program. Residential claims from 1997-2006 were reported at about 35% of all claims filed against architects. This reflects a 30% increase in residential claims over the past 10 years. Going forward, architects should use this data to formulate business plans and begin assessing the type of projects they are going to pursue in the future.
Select the Right Professional Liability Insurer
In the 1980’s, there were less than 10 professional liability insurers offering coverage to architects. Today, there are well over 30 professional liability insurers. The competition to write professional liability insurance for architects is at an all time high. With the influx of insurers and “soft market” insurance rates, architects do have options.
However, there are a number of factors firms should consider when selecting their professional liability insurer, including:
- Insurer’s financial rating (A.M. Best or S&P)
- Longevity in writing architects professional liability insurance
- Assessment of the coverage being offered, as all policy forms are different
- Insurer’s claims management procedures
- Any outside or additional risk management services the insurer may offer
Price may be the primary reason for shopping for an insurer, but due diligence is paramount. As the saying goes, “you get what you pay for.” Make sure the policy matches your needs as well as your budget.
Understand Rates and Coverage Options
Traditionally, professional liability rates trend upward in a down economy. That is definitely not the case in the current economy. Even though insurers have seen an increase in claim activity and insurers’ investment income may not be what it used to be, the competition and capacity have kept premium rates at an all time low.
The differences we are seeing in today’s insurance market compared to that of the mid-1980’s is “soft market” rates versus “hard market” rates. During a “soft market,” premium rates are competitive and insurers will often expand the breadth of coverage whereas “hard market” premium rates escalate and in some cases restrict coverage. In the mid-1980’s, not only were architects being hit with an increase in claim activity but insurance rates escalated. This is not the case in 2009 as rates continue to be “soft” and coverages extremely broad, but the level of claim activity is beginning to rise.
In order to help save on premium costs, some architectural firms have considered lowering their policy limits and increasing their deductibles. However, before firms make such changes, architects should review their contractual obligations with clients as often times the limits maintained are required by contracts and for an extended period of time following substantial completion of a project. In addition, it is important to seek the advice of your professional liability broker whenever considering changes of insurer, limits, deductibles, etc.
Know What Underwriters Look For
Believe it or not, completing the professional liability application accurately can save premium dollars. It is important that billings be allocated to the appropriate categories. Feasibility studies, abandoned projects, project specific policy billings, international work, CM services, insured subconsultant pass-through fees and direct reimbursables are categories in which underwriters will provide significant discounts to and/or exclude from their premium calculation.
The same holds true in accurately reporting your firm’s areas of professional services. Underwriters view certain categories as lower risk and therefore provide credits (i.e. interior design and landscape architects) with other categories viewed as more risky therefore generating debits (i.e. structural and geotechnical engineering). If there is a category of services that needs to be listed as “Other”, there should be a thorough explanation of those services. The credits and debits of this type of service vary by insurer, so you should request assistance from your insurance broker.
In the past year, we have seen revenues at architectural firms drop substantially and the forecast for the remainder of 2009 and into 2010 is still troubling. Based on history, professional liability rates cannot and will not stay “soft” forever. It’s just a matter of time before we see the rate pendulum swing. Now is the time for architects to truly understand their professional liability risks and how to manage them in the future.
 |
About the Author
Brett Gough is a senior vice president at Ames & Gough, an industry-focused specialty insurance brokerage. He is responsible for client management on many key design-firm clients and is also active in the firm’s law-firm initiative. Brett is active in various New England industry associations and is asked to speak on professional liability insurance and risk management issues. He can be reached at 617-328-6555 or bgough@amesgough.com. |
September 11 – REFA Fall Conference
September 16 – REFA Industry Leaders Series
September 16 – Greater Boston Chamber of Commerce - Women's Network Breakfast
September 18 - Association for Corporate Growth – DealMakers Breakfast
September 23 – Small Business Assoc. of New England (SBANE) - MA Breakfast Series
September 23 – Greater Boston Chamber of Commerce - Government Affairs Forum
September 29 – TMA – Troubled Times: Challenges and Opportunities in Distressed Real Estate
Click here to UNSUBSCRIBE.
Copyright (c) DiCicco, Gulman & Company LLP
150 Presidential Way, Suite 510 | Woburn, MA 01801 | Tel: 781-937-5320
|
