How to read a Profit & Loss statement

The Profit & Loss statement is one of the fundamental financial forms of all businesses including architecture firms. This report takes a snapshot of the financial information for a set period of time, typically on a monthly, quarterly or annual basis. It is important for all firm owners and those considering starting their own firm to understand what this report is and how to read one.
By
Lucas Gray

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Introduction

Running a small architecture firm is tough. It can be stressful, demanding, and there often seems like a million tasks that need your attention at any given time. Considering that most people get into this profession for the love of design, all too often this means that the business and financial sides of running a company can often be neglected, or overlooked, as deadlines and clients demand our attention.

Yet as a business owner it is vital that you and your partners, if you have them, carve out the time necessary to review our financials on a regular basis. If the health of the business isn’t strong, then you won’t be able to serve your clients or deliver great design work. Ideally this means looking at how your business is doing on a monthly basis, with quarterly or annual reviews that dive into more detail and allow you to make adjustments and plan for the coming months.

The best tool in your belt for this sort of snapshot of financial health is the Profit and Loss Statement. This report presents all of the revenue and expenses over a set period of time, and can clearly show the profitability (or not) of the business. It can also give you a chance to adjust where you are spending your money, where you may need to cut back, and if you need to focus on bringing in new projects to have your revenue cover the cost of operating the firm.

To help you understand the P&L report we are going to break down and actual statement from a small architecture firm. Looking at the main sections of the report as well as doing a deep dive into each line item, you will get a chance to see where money was spent, how revenue was generated, and some insight into what each expense category covered. We will also talk a bit about profitability, annual targets, and budgeting.

Overview

Looking at the entire Profit & Loss report, we can break it down into five main sections:

  1. Revenue (or Income)
  2. Cost of Goods Sold (or Direct Expenses)
  3. Operating Expenses
  4. Other Income
  5. Net Profit

Considering the main graphic of the sample P&L statement, you can see each of these sections in the rectangles. The green rectangles reflect revenue and the red rectangles include all of the expenses. Throughout this article we will go over each of these sections, highlight the main things to look at, and discuss specific line items that may vary from year to year and office to office.

Overall a Profit & Loss report gives you a quick snapshot at the financial status of the business, how profitable it is, and where you can focus on reducing expenses or growing revenue. You can set the time frame for this report within Quickbooks Online or other accounting software - either for monthly, quarterly, year-to-date, or annual reports.

It is good practice to review the P&L statement for your business on a monthly basis with the firm partners to make sure you are staying profitable and to adjust for any unexpected changes from your annual budget. We typically looked at a year-to-date P&L report each month and compared it to our annual operating budget. At the end of each year we would review the full annual report and use it to set the budget for the upcoming year.

Section 1: Revenue

This section covers almost all of the money coming into the company. As an architecture firm there are a few different categories of revenue so we broke down this income into 7 line items.

As you are setting up a new business consider the categories that you would want to track going forward. You could simply copy what is here or if you anticipate having different revenue streams feel free to add those to your report and have your bookkeeper categorize the revenue accordingly.

In our case we wanted to track fees for our work, revenue to cover reimbursable expenses, and then the revenue related to marking up reimbursable expenses. We did this in both the revenue and the Cost of Good Sold sections so we could check each category to make sure that we correctly invoiced for all of our expenses.

The first three lines are for markups on all of the reimbursable expenses we paid on behalf of clients.

2 - Markup on Permit Fees

3 - Markup on Consultant Fees

4 - Markup on Reimbursable Expenses

For any direct project expenses that we incurred, we would add a 10% markup to cover the admin of paying and tracking expenses as well as the risk of not recouping those costs. This 10% markup ends up as gross profit for the company.

These markups were applied to the three main reimbursable expense categories that we incurred on most projects:

5 - Revenue from Consultant Fees

Most projects require consultants necessary to complete the work. This would include structural engineers, civil engineers, landscape designers, arborists, or any other outside consultant that was part of the design team. Again, we would give our clients the choice to pay the consultant directly to save on our markup fees, but typically we would pay the consultants and then invoice the clients for their work along with ours.

6 - Revenue from Reimbursable Expenses

This would be all the little things that you pay for in order to complete project work. If you send drawings to a printer that would be a reimbursable cost. If you drove to the City to drop off drawings, or you drove to a meeting at the client’s property, those would be reimbursable expenses. We did our best to keep these to a minimum and did a lot of our work digitally to keep printing costs down. However, most projects still had some expenses that would fall in this category.

7 - Revenue from Permit Fees

When we submitted projects to the building department for review, they would be assessed an intake fee - typically around 10% of the total permit fees. We often paid this fee to expedite the submission process. If we paid the fee on behalf of the client we would mark it up 10%.

Some clients wanted to pay the city directly to save on these markups. In this case they would either give us a blank check made out to the city that we would fill in when we got the total intake fee amount, or they would meet us at the city building department and pay them directly. However, most clients simply preferred having us deal with this and invoice them for it later.

In our Profit and Loss statement you can see that we have three line items for the markups for these categories (profit), and then three line items for the revenue that covered those expenses directly, which should cover most of the corresponding line items in the expenses section. We broke these fees out so we could track if we were invoicing for the markups relative to the reimbursable cost.

For instance you can see that line 2 is approximately 10% of line 7. There can be some slight discrepancies for a variety of reasons - mainly that we often invoice for some reimbursable expenses a month or two after we incur those costs. For example, some of the reimbursable consultant costs from 2019 may actually be invoiced to our clients in 2020 which is why that line item in the cost of goods sold section may not equal the corresponding line in the reimbursable revenue section.

Sometimes we also didn’t add a markup if we had to reprint something because of a mistake on our part or something, so these didn’t always match up 100% of the time, although they should be close.

(Note: within Quickbooks Online, if you ran this report and then clicked on any of the line items it would open up a detailed report with all the expenses in that category. Approximately once a quarter or so we would go through the reimbursable categories in the revenue and cost of goods sold and match the line items to make sure we didn’t miss invoicing something.)

8 - Sales

This category covers all of the fees we charge our clients to execute the architectural design work. This was either hourly fees for our time, or the lump sum fees based on the contracts we signed. Sales revenue will cover all of the overhead expenses in section 3 as well as any shortcomings from the reimbursable expenses.

This line item is clearly the biggest revenue source and the root of every design business. You are selling your time and expertise and all revenue related to your services should end up here.

As you can see our total revenue, including all of the reimbursable expenses, was around $579,000.

Section 2: Cost Of Goods Sold / Direct Expenses

This section is all of the expenses we incurred on behalf of our clients. As we touched on above, this would include any out-of-pocket expenses like printing, travel, permit fees, consultant fees, etc. If we spent something on behalf of our clients, it would fall in the Cost Of Goods Sold section on the Profit and Loss statement.

Again, we wanted to track the main areas where money was being spent so we could make sure we were correctly invoicing and recouping those expenses.

11 - Quickbooks Payment Fees

We used the integrated Quickbook electronic payment system for our clients to pay online - hopefully thus avoiding mailing checks. There were some fees invoiced in this depending on how they paid.

If they used a debit card or bank account the fees were pretty minimal - something like $0.50 or $1 per transaction. However, if a client paid by credit card we would be charged up to 3% of the transaction fee. Because that 3% could add up quickly, we eventually stopped accepting credit card payments.

12 - Consultant Fees

As we mentioned in the section above, we incurred costs associated with hiring consultants needed to complete our work. These expenses should correspond to Revenue in the section above. If you track your expenses and invoices carefully you should have the revenue and expenses for Consultants match over time.

13 - Reimbursable Expenses

The cost of printing, mail, transportation, or other expenses directly related to executing the work on a given project.

14 - Reimbursable Permit Fees

The cost of paying for permit intake fees and overall permitting fees assessed by the local jurisdiction. These can vary greatly from project to project depending on the size, value, and the fees set by the local building department.

At the bottom of this section it shows that our total Costs of Goods Sold was very close to $50,000 (line 15). Subtracting this from our Revenue leaves a Gross Profit of just about $529,000 (line 16).

This is the amount of money we made before we take any of the firm’s operating expenses into account. Obviously, the goal is to keep the overhead expenses below this number so we have a net profit at the end of the year.

Section 3: Operating Expenses

In this section we break down all of the expenses required to keep the firm running. This includes everything from office furniture, computers and software, to insurance, marketing, and wages.

This section is also where you have to budget and track your expenses carefully. Firm owners have a lot of discretion over where you spend your company’s money so consider each category and assess what an appropriate budget should be. Why is each expense beneficial to your business and how can it help you deliver great work, support your employees, and ultimately make your company more profitable?

There may be places that spending some money can help land new clients - marketing for instance - and thus the more you spend the more revenue for the company. Other places may make your employees more productive - professional development or new software are a couple of examples.

While others may be places you can cut down on to increase your profits - do you really need new office furniture this year, or did you take the company out for meals too often? How does the firm culture and happiness of your employees translate to better performance and profits? All of these questions should be considered when budgeting for each line item in the operating expenses.

Let’s go through this section of the P&L Statement line item by line item and discuss what each category covers.

18 - Accounting

This is where all expenses related to accounting go. Typically this would include paying for our tax preparations on an annual basis. We also would occasionally meet with our accountant throughout the year to discuss the financial state of the company and see if there were any opportunities to reduce our tax liabilities. We also would put bookkeeping costs in this category (some firms might want to break this out into a separate line item or do their own bookkeeping).

19 - Bank Charges

From time to time banks may charge some fees related to their accounts and services. In our case, we worked on a couple of international projects and when we traveled for these projects we were charged some international ATM fees for cash withdrawals. Also if our company checking account went below a certain balance our bank charged a fee. There also could be bank charges related to loans or other banking services. In general, with careful planning this could be $0. In our case it was still very low.

20 - Business Taxes

To operate a business there are certain taxes and fees assessed by local, county, or state jurisdictions. These are different from income taxes so we broke it off into a separate line item. Often these are proportional to the size of the business or your annual income or number of employees, so can vary from year to year as the company grows. Researching what the local fees are in your location is important and could affect where you decide to locate your business.

21 - Charitable Contributions

This category is self explanatory and is completely up to you on whether to donate as a business. In our firm, we sponsored a design award for the top graduating student from Portland State University’s Architecture school. Each year the faculty would choose the top student based on their accumulative design work and that student would be awarded $500.00 from our firm.

We felt it was important to support the next generation of architects and also used this to introduce our firm to all of the graduating students, hopefully encouraging the top students to want to work for us if there were positions available. Occasionally we would also donate to other non-profit organizations like affordable housing developers or community groups we worked with. Typically we would budget between $500 and $1000 in this category on an annual basis. The goal was to increase this as our revenue grew.

22 - Computer Software

This is a relatively big line item and something that you do have a lot of control over. This covers all of the software programs we purchased to run the firm. For instance we paid for the following software: Revit LT, Bluebeam, Adobe Creative Suite, Monograph.io, Google Suite, Quickbooks Online + Payroll, Squarespace, Calendly, and probably a few others I’m forgetting about. Most software is on subscriptions these days so many of these were ongoing monthly or annual costs.

We tried to be diligent in making decisions on what software was absolutely necessary to complete our work and make us more productive while keeping our ongoing costs to a minimum. This is a category that could balloon to a much bigger expense depending on your design process, how you manage projects, how many employees you have, and what software you use for various tasks.

23 - Computers and Technology

Pretty self explanatory, but any expenses related to purchasing computers and technology equipment would be categorized here. This category can change drastically year-to-year depending on your needs. In 2019 we didn’t buy any new computers and if I remember correctly we only purchased a new power adapter and a couple new mouses. However, in 2018 we purchased 5 new wide screen monitors and two laptops.

Overall we probably spent around $6,000 or more in 2018 compared to 2019. Besides computers, other things that could fall in this category are projectors or TV monitors, speakers, routers, modems, misc. cords and adapters, digital cameras, virtual reality headsets, or any other technology equipment that your firm uses. However, don’t put software or subscriptions here. Only include the purchase of physical assets in this category as the value can be depreciated on your tax returns.

24 - Insurance

There are a bunch of insurance expenses for each business and thus there are subcategories under the general topic. In our case we had the following policies:

25 - Health Insurance

We offered health insurance, dental coverage, and vision to our employees. These benefits were better than most other firms of our size, but it was important to our employees and we justified the additional expense as a way to retain and attract the best people.

26 - Owner’s Insurance

Based on recommendations we purchased both a Disability and a Life Insurance policy for the three partners. The idea here is if any one of us got sick, disabled, or passed away, the firm would get an influx of cash to compensate for that partner no longer contributing to the company. In the case of death, the life insurance policy could also be used to buy out that partner’s shares from their family.

27 - Workers Compensation

Mandated by the state, this covers any injuries or accidents that could cause injury while employees are at work.

What is missing from our 2019 expenses is Professional Liability insurance and general business insurance. We purchased 3-year policies for these and it was a bit cheaper to pay up front rather than spread payments out. Thus they don’t show up on this annual P&L statement, but rather only on the year we purchased that policy.

However, it is important to budget for those costs so don’t forget that some expenses might not show up on each annual report. When planning your next year’s budget, look back at the P&L reports from a few prior years to hopefully catch any of these less frequent expenses.

29 - Legal Fees

Make sure you have a good lawyer to represent your firm. Ask other established architecture firms in your area who they use to get a list of recommended attorneys. Interview a few of them to find one that you trust and has a good reputation. Every business will run into legal issues from time to time and it is important to have someone to help guide you through those.

In our case, we restructured the business from an LLC into an S-Corp in 2019 to include a third partner and address some tax and legal issues related to how we were practicing. We also filed a trademark for our name and logo and had a few other legal questions throughout the year.

30 - Licenses

In most places you need a license to run a business and also a license to practice architecture. This line item is where any expenses related to these licenses lie. This is another place where not all expenses are annual though.

Architectural licenses are renewed every 2-years in Oregon so this line item can vary from year to year.

31 - Marketing

This is an expense that is completely in your control. It isn’t necessary to spend anything on marketing although most companies do budget for some. Depending on where you read some statistics, you can find that the average spend on marketing can be anywhere from 4-8% of your annual revenue. We ended up at only 3% so perhaps we should have spent a bit more to attract additional projects or higher-fee projects.

Expenses that would fall here are things such as website costs (design, hosting, templates, etc.), printed marketing materials (business cards, brochures, yard signs, construction site banners, etc.), cost of attending events, memberships in business or networking organizations, online advertising, print advertising, and others. In our case we combined our marketing and business development expenses into this one category.

32 - Meals

Throughout the year we paid for a lot of meals, either for the office, for clients, for partner meetings, etc. We would typically budget about $200/month for this category and encourage partners to take leads out for coffee, meet with a prospective client over drinks, or have lunch or dinner as a firm for team building.

To be honest, I think what we budget was a bit low. We should have been doing more meals and drinks with potential clients and if I was starting out I would budget spending $100/week. Building relationships is incredibly important and valuable and worth the investment. This used to be a category that was deductible on your taxes but that changed with the recent tax laws. Check with your accountant regarding the tax implications of this expense.

33 - Office Expenses

Everything from new furniture to trace paper will fall here. It should encompass all of the various expenses you need to keep the office supplied and comfortable for your staff to do their work. Pencils, pens, paper, chairs, art, acoustic panels, post-it notes, a kegerator if that is your office culture… really anything that you feel your office can use.

This category is variable depending on the firm and can also vary from year to year depending on specific needs. In 2019 we had a couple of sit-stand desks ordered and a couple of custom made tables for our conference room fabricated. In other years we didn’t buy any furniture so our expenses were lower. This category will also increase as the firm grows considering you will need new furniture and supplies for each new employee.

34 - Payroll Expenses

By far the biggest expense for any service based company like architecture firms is the cost of their staff. As you can see it dwarfs the other expenses in our P&L statement. There are a few categories of Payroll Expenses that we break out to track. These are:

35 - Retirement Contributions

We offered a SIMPLE IRA retirement plan with a company contribution of 2% of an employee’s annual wages.

36 - Payroll Taxes

Payroll taxes are set by the federal and state levels and are automatically paid through our payroll service (we used Quickbooks Online payroll which calculated and paid these on our behalf).

37 - Wages

the salaries that we paid to our employees. We had 4 people employed full time for 12 months and 1 employee who was full time for about 10 months of the year. The partners also took a salary although we paid ourselves below market rate for our experience level. We took extra compensation as owner draws throughout the year, or annually depending on profitability.

As you can see wages is the main expense. To make sure the business remains profitable it is important to balance your staff with the amount of work you have. It is also important to consider market rate wages for the level of experience you need your staff to be. It might not be more profitable to hire a less experienced staff member just because their wages may be lower. You still need to make sure the work gets done in a timely manner and to a high standard of care.

It may make sense to have fewer highly experienced staff vs more junior staff. Consider this carefully as you decide when and who to hire as your workload changes over time. One other note about wages. As an S-Corp we paid ourselves as partners a monthly salary. However, our salary was based on our cashflow and significantly below what we would have been paid for our experience level at other firms.

The idea is that the profits of the business will make up for that shortfall. If we were paying ourselves a market rate salary then the payroll expenses would have gone up significantly.

39 - Phone

Nothing super profound here. Communication tools are essential for every business. To keep our firm nimble, we covered the cost of mobile phones for our staff. We found that with flexible hours, some people working from home from time to time, and with us often out of the office at meetings, having a fixed office phone didn’t make sense. We simply bought mobile phones and covered the cost of those plans as a firm.

Of course, we were a small office and this might not be the right solution for larger firms with many more employees, but it worked for us. We used Google Fi as our service provider and paid around $220/month for 4 lines with unlimited voice, text, and data.

40 - Postage and Shipping

This is quickly becoming an obsolete expense with most communication and work becoming digital. Plus with any direct project expenses categorized in the Reimbursable Expense line item at the top, all that falls into this category would be random mail throughout the year. Sometimes we would mail a thank you card to clients when their projects were completed, or have to send a form or a payment to a government agency.

Occasionally we would buy a big book of stamps to have on hand for random mail, so probably half of this 2019 expense would cover us for the next year or two.

41 - Printing

This category should not be confused with printing expenses related to billable projects. Those should end up in the reimbursable expenses in the Cost of Goods Sold section. What ends up here is the printing expenses for the office.

Things like printing out reports to share with the partners, or misc. forms that need to be filled out and mailed. In general, we tried to keep this to a minimum to save costs and paper. However our approach did shift over the years.

At the beginning we were very diligent at tracking all in-house printing and then billing it to clients. However, this was taking a lot of time to track and invoice - more time than the value of getting reimbursed for those.

Thus we changed tactics. For any project related printing at milestone deliverables we would send the printing out to a print shop and invoice that expense to our clients. For day-to-day printing that we did in house, we decided to just categorize that as overhead and not track each time we printed.

Instead, we leased a printer from a company that included a set amount of B&W and Color prints in the monthly fee (we rarely went over the limits), and included the equipment, technical support, and printer ink.

Overall we spent about $100/month for the lease and paper costs. We chalked up this monthly fee to overhead to save on the time needed to track everything. Overall I think this was the right choice so we could instead spend our time on billable work.

42 - Professional Development

Knowing that wages is by far your biggest expense, it is important to invest in your staff. You need to keep people up to date on the latest technology, materials, software and knowledge related to your project types. It is also important to offer people learning opportunities and support their goals so you can retain your staff.

At our firm, we offered each employee a $1000 annual allowance to spend of professional development. $500 was targeted towards membership dues, exams, etc. while another $500 was for attending events or conferences, taking classes, or other educational opportunities.

This gave each employee some flexibility to pursue their interests or career goals. One used this to cover ARE exams and study classes, another used their allowance for travel and accommodations to attend a conference. Most of our staff were also members of the AIA and could use this allowance towards those dues. It was important for us to both encourage people to get engaged outside of the office, but also give them the freedom and flexibility to spend these funds on something that was important to them individually.

43 - Rent

Outside of labor this was our single biggest expense. To be frank, I think we were spending a bit more on rent than we should have considering the size of our firm, and if we spent more time searching we probably could have found a less expensive office. However, location was important and we were centrally located in the city and easy to access for all of our employees and clients.

We also got a larger space than we needed with the goal of growing into it over the years. In the meantime we subleased a couple desks in the office to an architectural photographer and another architect who specializes in envelope consulting, in order to reduce our costs.

44 - Transportation

We all need to get around and that has an associated cost. For us, this included reimbursing each other for work related travel in our personal vehicles (using the standard federal mileage rate), taking taxis/uber/lyft to meetings or events, or using car share services like reachnow or car2go for business related transport. We also offered transit fare cards to our staff. In general, we used this to track local transportation expenses related to the business.

45 - Travel

We kept travel separate from transportation considering we did some international projects and a few of us also attended conferences and events out of our region.

Particularly, for our work in Japan, we would travel there about once a year and a couple times brought the whole office. The business covered flights and accommodation for these trips. As opposed to the transportation line item, travel was for long-distance trips and we kept it separate so we could budget for it on an annual basis.

46 - Utilities

We were lucky in that our rental agreement included all utilities except for internet service. This made tracking our utilities pretty easy and also kept this category to a minimum (but was reflected in the higher rental costs). With comcast internet service our monthly cost was only around $85. Typically a firm could expect to have electricity, water, gas, garbage, security, internet, and perhaps cleaning, in this category.

Adding all those up and we have around $460,000 in overhead expenses (line 47). It is useful to then calculate your monthly cost of running the office. In our case, that is $460,000 / 12 months = $38,333 per month.

This means we need to bring in that much revenue each month to break even. This can help you set goals for business development and making sure you are signing enough new contracts to cover expenses over the coming months.

Section 4: Other Income

Next we have a small section called other income (line 49). For us there wasn’t much coming in outside of our basic services. We only had a couple of dollars worth of interest from our bank accounts (line 50). However, some firms may own property they collect rent on, or sell products that supplement their services, or maybe have investments that bring income into the business. Those can all end up here.

Section 5: Net Profit

This is the most important number on this report and should almost always be positive considering the goal of a company is to make money. A good rule of thumb is that your business should have a net profit rate of approximately 10% or more of gross revenue.

52 - Net Profit

If you take our gross revenue and subtract our overhead expenses you get our net profit of around $69,000.

To get the profit percentage we can divide $69,000 by $529,000 for a profit margin of 13%. This is not bad, although it is important to consider that the partners were paid a below market rate, and some of our insurance expenses didn’t show up on this year’s P&L Statement.

To be honest, we were targeting 15% or more for our 2019 profit margin so fell a little short of our annual expectations. However, we did grow our revenue and profit significantly from the previous year so in general we did pretty well.

This profit is then used for a variety of things. Some is kept within the business to have on hand to invest in future needs, or as a “rainy day fund” to cover our monthly expenses if something happens - like a recession or pandemic and fees or new project leads dry up. Having about 6-months of operating expenses in a savings account is ideal.

In our case that is $460,000/12 x 6 = $230,000. To be honest we never quite got there. We routinely had about 1-2 months of reserve funds, although we were slowly building up to more. Typically we would put $2,000 into our savings account each month to build up these reserves, and more at the end of the year if the profits allow it.

We divide some of the profits as additional income for the partners. In this case we took owner draws of around $10,000 per partner. We also use some of the profits to give bonuses to our staff. We aimed to give 10% of our profits as bonuses.

We also used profits to purchase things for the business. If we needed new computers or furniture, or we wanted to buy something fun for the office like smart speakers or a kegerator, this is what would cover those expenses. Or we would do a fun activity for the group, like a team dinner, an escape room, or even that trip to Japan that I mentioned above. Typically those expenses would end up showing up on the following year’s P&L statement.

Conclusion

This report gives a quick overview of the financial health of the firm and is important to review it frequently to track how the company is doing. I would look at this report on a monthly basis and compare it to our annual budget. At the end of each year I would also utilize this report to project the following year’s revenue and expenses and build out a new company budget.

We would also occasionally share this information with our employees as we wanted to have them engaged with the financial standing and success of the business. We felt that transparency with our revenue and expenses would foster a team-wide attention to financials, and would lead to more profitability.

If each team members understands the relationship between the sales and their wages and time, we can better manage our staff and everyone can contribute to creating an efficient design process.

The Profit and Loss Statement may be the most important document you review on a regular basis. It is good practice for all the partners of the business to review this together on a monthly basis, and utilize the information to make adjustments necessary to keep the business on track.

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