Top 3 Most Important Balance Sheet Ratios for Professional Services Firms

By |2018-10-16T16:21:35-05:00August 16th, 2015|Categories: Deltek|Tags: , , , |

This post was authored by Megan Miller of the Deltek Vision marketing team—follow her on Twitter.

Managing a professional services firm feels like a constant balancing act. What is the right mix of utilization, profitability and overhead? Where should the firm invest and what is a safe amount of debt to carry without jeopardizing the firm’s health? There are circumstances and variables unique to each organization that make a one-size-fits-all solution impossible.

But, understanding some key balance sheet ratios, what they mean for your firm and how others in the industry are performing can help you set informed and strategic targets for your organization. What are the high performing firms in the industry doing? What are the trends and what do they mean? And, how do you measure up?

All data facts and figures referenced in this blog post come from the 36th Annual Deltek Clarity A&E Industry Study. This report surveys hundreds of architecture and engineering (A&E) firms each year in North America to set benchmarks for firm project management, financial, and business development performance. The study includes firms of all shapes, sizes and disciplines creating a diverse representation of the state of the industry.

So, what are some of the key financial ratios you need to monitor and how does your firm measure up?

Related article: Key Findings from the 2015 Deltek Clarity A&E Industry Report

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1. Average Collection Period

The average collection period is the length of time it takes to collect accounts receivable (A/R) from clients. This is from the time the invoice is entered into A/R to when it is credited against A/R. Being able to convert an invoice to cash quickly is a sign of billing efficiency and accuracy, and financial health for a firm. In 2014, the average collection period declined by just one day and is still eight days longer than it was in 2010.

deltek-clarity-2015-average-collecting-period

This is an area where many firms have room for improvement. There is quite a bit of difference when comparing high performing firms vs. all others and large firms vs. medium and small firms as seen below.

deltek-clarity-2015-average-collecting-comparison

As a small firm, you may not have the capital to loan your money to clients at zero interest. Expediting the collection process can be huge for your firm.

If you were to follow an invoice from start to finish, what is the process to get you reviewed and approved by a PM, to a client and then back to the firm with payment credited? Where are the inefficiencies and bottlenecks? Where are there manual processes that can be streamlined and automated?

What improvements can you make to increase your cash flow?

For this report, the average collection period is calculated by dividing accounts receivable by annual total revenue, times 365.

2. Current Ratio

The current ratio looks at the relationship between a firm’s liabilities or debts and the firm’s assets. This helps determine the financial health of the organization. In other words, if something happened to your organization and you had to sell your assets to cover short-term debt, would you have anything left? Could you survive?

In 2014, the average current ratio decreased slightly to 2.44. The number has decreased for the first time in several years, which may be a result of growth and often puts a strain on firm’s short-term capital.

deltek-clarity-2015-current-ratio-trend

If your ratio is less than one, you may not be able to pay short-term debts and are putting your firm at risk. Why does this matter? If you have internal or external shareholders, your current ratio helps them better understand the organization, and its financial stability.

For clarification purposes, the current ratio is calculated by dividing current assets (cash and near cash assets) by current liabilities (those due in one year or less).

3. Debt to Equity Ratio

The debt-to-equity ratio is a measure of the relationship between the company’s debts and the stockholder’s equity. This is a measure of a company’s financial leverage. The debt to equity for the average firm was unchanged in 2014 at 0.82. While there is little change to the ratio over a three-year period, there are variations between firm sizes and types as seen below.

deltek-clarity-2015-debt-to-equity-ratio

Monitoring this ratio is key because it helps firms better understand how successful their growth strategies are. Are growth initiatives being financed through debt? Are there better ways to finance those strategic initiatives without putting the company at risk? Are the ratios too low and is the firm missing opportunities to take advantage of available equity to leverage growth?

The Architectural & Engineering Clarity study calculates debt to equity ratio by dividing total liabilities by stockholders’ equity.

More Key Financial Metrics

These are just three of the key financial metrics included in the study that your firm should be monitoring regularly and benchmarking against other firms. By benchmarking, you can find your bright spots and areas for improvement.

Related article: Top 3 Income Statement KPIs for Professional Services Firms