Firm Financial Management and Risk Control
Reading the Numbers
Firm financial management rests on three statements: the balance sheet, which shows assets, liabilities, and equity at a moment in time; the income statement, which shows revenue, expenses, and profit over a period; and the cash flow statement, which explains changes in cash. Accrual accounting recognizes revenue when earned and expenses when incurred; cash accounting recognizes them when money moves. Profitability analysis uses direct labor as the denominator because labor is the firm's primary controllable cost.
Key metrics: utilization rate = direct project hours ÷ total paid hours. Overhead rate = indirect expenses ÷ direct labor. Net multiplier = net fee ÷ direct labor. Break-even multiplier = (direct labor + overhead) ÷ direct labor; it excludes profit. A project is profitable only when its net multiplier exceeds the break-even multiplier. Markup and margin are not the same: a 20% markup on cost yields a 16.7% margin.
Risk and Insurance
Risk control includes contract review, limitation of liability clauses, indemnification, and dispute resolution. Professional liability policies are usually written on a claims-made basis, covering claims reported during the policy period; occurrence policies cover incidents that happen during the period regardless of when reported. General liability, auto, and workers' compensation cover different exposures. Never assume a policy covers a scope of work without checking exclusions.
Trap: candidates confuse claims-made with occurrence, or assume a net multiplier includes profit. Another trap is treating accounts receivable as cash; unbilled WIP and slow collections can bankrupt a profitable firm.
Worked example: Direct labor is $100,000, overhead is $150,000, and net fee is $300,000. Net multiplier = 3.0; break-even multiplier = 2.5; overhead rate = 150%; profit = $50,000. If the fee had been $240,000, the net multiplier would be 2.4 and the project would lose $10,000.