What Is a Net Multiplier, and What Should an A/E Firm’s Be?

How to calculate the overhead rate and net multiplier from the firm’s own books

The work takes three exports from the last full fiscal year: the profit and loss statement, the payroll register and the timesheets by project. FAR 31.203, written for government contracts and used here only as a checklist, describes indirect costs as those remaining after direct costs “have been determined and charged directly to the contract or other work,” accumulated “by logical cost groupings” and allocated on a base that reflects “the benefits accruing” to the work. This guide uses direct labor as the base. The bookkeeper can do every step below:

• Total every salary paid for the year, principals included. If an owner takes distributions instead of a salary, put a salary for the owner’s role on its own line, so unpaid principal time does not make the overhead rate look lower than it is.
• From the timesheets, multiply each person’s hours charged to projects by that person’s hourly salary. The total is direct labor. Hours coded to proposals, marketing, training, administration and paid leave stay out of it.
• Put everything else on the profit and loss statement that is not a consultant fee or a reimbursable expense into the overhead pool: the remaining salary, payroll taxes, health coverage and retirement, rent, software, professional liability insurance, marketing, accounting, and interest on the line of credit.
• Compute net service revenue: fees earned for the year, minus consultant costs and reimbursable expenses billed through.
• Divide overhead by direct labor for the overhead rate, and net service revenue by direct labor for the net multiplier.

Illustrative example: a hypothetical firm paid $2,000,000 in salaries last year. Its timesheets show that $1,240,000 of that salary, 62 percent, paid for hours charged to projects, which leaves $760,000 of salary in overhead. Payroll taxes and benefits add $500,000, rent $240,000, software and IT $150,000, professional liability insurance $90,000, and accounting, marketing and everything else $200,000, for an overhead pool of $1,940,000 and an overhead rate of about 156 percent. The breakeven multiplier is about 2.56. The firm earned $4,300,000 in fees, of which $580,000 went to consultants and $120,000 was reimbursable expenses, so net service revenue was $3,600,000 and the net multiplier about 2.90. Profit before tax was $420,000, about 11.7 percent of net service revenue. Replace every number with the firm’s own.

How billing rates follow from salary cost and the multiplier

A billing rate is an hourly salary times a multiplier. The hourly salary is the annual salary divided by the hours the firm pays for in a year, 2,080 for a full-time employee paid for 40 hours a week. The multiplier in the rate table is the target, not the breakeven: a table set at breakeven earns nothing even when every project hour is billed, and loses money on every hour written off.

Illustrative example, at a target multiplier of 3.0: a designer paid $62,400 a year costs $30 an hour and bills at $90; a project architect at $93,600 costs $45 and bills at $135; a principal at $166,400 costs $80 and bills at $240. The salaries are hypothetical. A rate table by job category rather than by person does the same arithmetic with the average salary in each category.

Rates go stale in one particular way: payroll moves and the table does not. If the project architect above gets a raise to $50 an hour and the table still says $135, every hour that person bills now carries a multiplier of 2.7. In the standard AIA owner–architect agreement, B101–2017, Section 11.7 lists the hourly billing rates and has them adjusted under the architect’s and its consultants’ “normal review practices.” That clause only helps a firm that has a review practice: a date each year, and a rule that a raise cycle triggers a rate check.

Federal-aid highway engineering shows the same arithmetic written into regulation. Under 23 CFR 172.9(b)(5), the specific-rates method pays for direct labor hours “at specified fixed hourly rates, including direct labor costs, indirect costs, and fee or profit.” Under 172.11, the agency applies the firm’s accepted indirect cost rate, which “shall not be limited by administrative or de facto ceilings of any kind,” and fixed fees above 15 percent of the total direct labor and indirect costs “may be justified only when exceptional circumstances exist.” Illustrative example: with a hypothetical accepted indirect cost rate of 150 percent, a $45 hour costs $112.50, and a 15 percent fee brings it to about $129.38, an effective multiplier of 2.875 on salary.

One gap between that structure and the firm’s own books matters for private pricing. The federal cost principles leave out costs a firm still pays: interest on borrowings (FAR 31.205-20), bad debts and the costs of collecting them (FAR 31.205-3) and entertainment (FAR 31.205-14) are unallowable. An audited indirect cost rate can therefore sit below the overhead rate in the firm’s own books, and a private rate table built from the audited figure leaves those costs, including interest on a credit line that carries slow-paying clients, with no billed hour to pay for them.

What multiplier the firm needs at its actual utilization

Utilization is the share of paid time charged to projects, and it moves the answer without any change to the rate table. Every unbilled hour does two things at once: its salary leaves direct labor and joins overhead. The same costs then produce a higher overhead rate and a higher breakeven.

The multiplier the firm needs follows from numbers it already has. All salaries plus the rest of overhead is the year’s cost. Divide that by one minus the target profit margin for the net service revenue required, then divide by direct labor. Measure utilization in salary dollars rather than hours where principals with high salaries bill little of their time; the hours ratio would flatter the firm.

Illustrative example, using the hypothetical firm above: its costs are $3,180,000, and a 15 percent profit on net service revenue requires about $3,741,000. At 62 percent utilization, direct labor is $1,240,000, the breakeven about 2.56 and the required multiplier about 3.02. At 55 percent, direct labor is $1,100,000, the breakeven about 2.89 and the required multiplier about 3.40. At 70 percent, direct labor is $1,400,000, the breakeven about 2.27 and the required multiplier about 2.67. Nothing in the rate table changed between those three cases. In this example, a slip from 62 to 55 percent means raising rates by about 13 percent to earn the same profit, or winning the hours back. The check that catches the slip is short:

• Monday: the office manager confirms every timesheet for the prior week is in, with each hour coded to a project and phase or to an overhead code. An hour nobody entered is an hour nobody bills.
• Weekly: utilization by person and for the firm, hours charged to projects against hours paid, next to the figure the year’s rate table was built on.
• Monthly: each project manager divides net fee earned to date by direct labor to date for each active project. Any project under the breakeven gets a written reason: hours over, scope added without an amendment, or a phase billed ahead of the work.
• Monthly: the bookkeeper reports the firm’s trailing twelve-month net multiplier against the breakeven and the target.
• Once a year, and after a new lease, a hire or a raise cycle: recompute the overhead rate, the breakeven and the rate table.

None of this needs new software if time is coded by project and phase. If it is not, that is the first fix, because neither the multiplier nor the next fee proposal can be checked without it.

Percentage of construction cost or hourly: which fee basis earns the multiplier

Neither basis earns the multiplier by itself. A percentage of construction cost pays the same whether the project takes 2,000 hours or 3,000. Hourly pays for every hour, but only for hours entered and billed at a current rate, and a not-to-exceed cap turns it back into a fixed fee at the top. The test for any proposal is the same: convert the fee into hours and compare them with the hours by phase on similar past projects.

Public work narrows the choice. FAR 15.404-4(c)(4)(i)(B) limits the price of federal architect-engineer services for public works or utilities, for the “production and delivery of designs, plans, drawings, and specifications,” to 6 percent of the estimated cost of construction, excluding fees. That is a ceiling, not a target. On federal-aid highway engineering contracts, 23 CFR 172.9(b)(2) says “percentage of construction cost methods of payment shall not be used”; the methods allowed are lump sum, cost plus fixed fee, cost per unit of work and specific rates of compensation. For private work the basis is the firm’s to propose, and the test is four steps:

• Fee for the firm’s own work: the percentage times the construction budget, minus the consultants’ fees it has to carry.
• Hours that fee buys: the firm’s own fee divided by the team’s average hourly salary times the target multiplier.
• Hours it will take: the average of three to five similar completed projects, from the firm’s own timesheets, phase by phase.
• Multiplier the fee earns: the firm’s own fee divided by those hours times the average hourly salary, phase by phase as well as in total. B101–2017 Section 11.5 leaves the share of the fee for each phase blank, from schematic design through construction, so the split is the firm’s to set from the same hours.

Illustrative example: a hypothetical $6,000,000 construction budget at 7 percent is a $420,000 fee. Consultants take $130,000, leaving $290,000 for the firm’s own work. At an average salary of $45 an hour and a target multiplier of 3.0, that buys about 2,148 hours. Five similar past projects took about 2,600, so the fee earns about 2.48, under the hypothetical firm’s 2.56 breakeven. The split hides it at first: if those projects spent 26 percent of their hours in construction administration and the agreement gives that phase 20 percent of the fee, $58,000 of the firm’s own $290,000, the design phases bill ahead of cost and construction administration runs at about 1.91, with the loss arriving after most of the fee is collected. The choices are a higher percentage, an hourly fee with a maximum, or less scope, such as a capped number of site visits, written into the proposal.

Can you ask for more fee when the client’s construction budget grows?

Under a percentage fee in the standard AIA agreement, part of the increase arrives without asking. B101–2017 Section 11.6 calculates the progress payment for each phase on “the Owner’s most recent budget for the Cost of the Work,” and adds that “Compensation paid in previous progress payments shall not be adjusted” for later budget updates. Phases billed after the increase follow the new budget; phases already billed stay where they were.

The redesign is a separate question. Section 5.2 says that if the owner significantly increases or decreases the budget for the Cost of the Work, the owner notifies the architect, and the two “shall thereafter agree to a corresponding change in the Project’s scope and quality.” Section 4.2.1.1 lists services needed because of a material change in the project, including in “the Owner’s schedule or budget for Cost of the Work,” among the Additional Services that wait for the owner’s written authorization. Under a stipulated sum, the fee does not move with the budget; only an authorized Additional Service or an amendment adds to it.

Owners edit these clauses. The University of Wisconsin System’s public copy of B101–2017 deletes Sections 11.5 and 11.6, and its Additions and Deletions Report is where the standard text quoted above can be read. Federal-aid highway contracts cannot pay engineering as a percentage of construction cost under 23 CFR 172.9(b)(2), and 172.9(e)(6) adds that overruns in the costs of the engineering work itself “shall not automatically warrant an increase in the fixed fee” on a cost-plus-fixed-fee contract, while permitted changes to the scope of work or duration may warrant considering an adjustment. Which clause governs a project, and what it allows, is a question for the firm’s attorney; this is a plain reading, not legal advice.

Illustrative example: a hypothetical $6,000,000 budget at 7 percent, with schematic design at 15 percent of the fee. Schematic design bills $63,000. The owner then raises the budget to $7,200,000. Under Section 11.6 the remaining 85 percent is paid on the new budget, $428,400, for a total of $491,400 instead of $420,000, before any Additional Services for the redesign itself. What makes that collectible is a record: the budget figure printed on every invoice, the date of each owner budget update, and an entry in the additional-services log for the redesign hours, with the owner’s written authorization attached.

When not to hire anyone for this, and where the Review fits

If the firm codes time by project and phase and the bookkeeper can produce the overhead pool, the arithmetic above is an afternoon’s work for a principal and the bookkeeper, and nobody needs a consultant. If the firm works mostly on contracts priced and audited under federal cost principles, it needs a CPA who prepares indirect cost rate audits, not us: we prepare no overhead-rate audit and nothing under federal cost principles. Agreement terms, a disputed fee and a budget change the client will not recognize are questions for the firm’s attorney.

An outside count earns a fee when the multiplier is one gap among several: time coded loosely, phases billed ahead of the work, extra services absorbed, consultant invoices passed through late, receivables that age. That is the work of an architecture & engineering business consultant who reads records rather than drawings. For a firm at about $1 million a year and up, the Revenue Review counts it under the Payment → Margin hand-off. From read-only exports of the profit and loss statement, payroll, timesheets by project and phase, agreements and invoices, it computes the overhead rate, utilization and the net multiplier each project and each fee basis actually earned, and prices the gap against the target as a monthly dollar figure wherever the records support one. It sets no rates and contacts no client. It takes two weeks. We are not architects or engineers, and there is no published A/E client case study on this site yet.

If the arithmetic above points here, the next step is a free 20-minute call, where we say whether the Review is worth its fee for this firm, including when it is not.