This post is the first in a series of articles where I will focus on Business Basics for Architects. Without the business background required for success, there are many relatively simple terms and strategies that we, as business owners, need to know but were never taught. These are the critical elements of business success that I wish I knew before launching Fivecat Studio.. but I didn’t know what I didn’t know.
The difference between gross income and net income, and why these terms are important for us to understand, is the subject of this first Business Basics for Architects article.
Gross vs. Net
Let’s start with gross income. In simple terms, gross income is all the money your firm makes. It should include all your fees, sales and payments made to the firm. Any transaction where money is flowing into the business is included in this calculation.
Net income (also known as Net Profit or The Bottom Line) is your gross income minus all your expenses, overhead and taxes. It’s what is left after you have paid your consultants, your vendors and the government. After all your outflows are complete, what is left is your net income.
A fun way to remember the term net income is to imagine that you pour all your income and all your expenses into a big net. The net catches all the expenses and all the income that is applied to those expenses. The money that flows through the net is your net income.
Why are they important?
Knowing the difference between gross and net income is important to the success of your business. Your net income is a metric that will show the relative health of your firm. If you’ve done your marketing well and focused on sales, you will have a bunch of new work leading to more revenue feeding your firm. Your gross income will start looking very impressive.
With all that growth though, comes increased expenses. You’ll start receiving more invoices from your consultants. You may need more staff, which will lead to higher payroll. Your workspace will start feeling a bit too cozy and you may need to move to a larger space. Your net income, what’s left after you pay all those expenses, will show you how well you are actually doing. Too many expenses and your net income will be begging for mercy.
Track your net income every month and you will see the trends of your business. During the summer months at Fivecat Studio we see our net income drop, but since we track net income as a metric, we can prepare for the annual low spots and have savings in place to cover our monthly expenses.
In a few weeks, I’ll share another Business Basics for Architects post. Leave me a comment below and let me know some of the basics on which you would like to brush up. What confuses you? What are some of the basics you wish you knew before launching your firm?
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Photo Credit: Shutterstock / Dirk Ercken
Thank you for the article! It’s always good to come back to the basics. I really enjoy your podcasts and blog!
I find that when trying to grow net income (or to have ANY net income!) by controlling expenses, it’s also sometimes helpful to think of “variable” vs. “fixed” expenses. Fixed expenses are those which are mostly out of my control on a month-to-month basis. For me as an architectural photographer, my those include my office rent, utilities like web hosting and internet service, my phone bill, and insurance. But if I’m looking to increase my net income, or simply reduce expenses temporarily during a lean period, I can look to cut my variable expenses like how much I spend on marketing, new equipment, professional development, and office supplies. As long as my total expense budget isn’t eaten up with all fixed expenses, I always have some flexibility to cut back on spending to get through a lean time if necessary.
I’ve always tried to treat marketing as a fixed expense — force myself to budget and pay for it on an annual basis so I’m not tempted to turn it off at the first sign of a cash flow issue. But how do others treat their marketing budget?
I recently realised after factoring in all of those “forgotten” expenses that I wasn’t even breaking even on one of the less expensive services I provide! Paying for software licenses was one of the main culprits. As a freelancer, that alone can equate to a couple of hundred dollars a month. What software do you recommend for tracking expenses?
We use Quickbooks for Mac for now, but we are looking into other cloud based platforms.
Mark, with all due respect, I offer a small, yet critically important correction to the reference to the term income vis-à-vis ‘gross income’ and “net income’, in your excellent article.
In financial management (fm) parlance, the term ‘income’ is a misnomer and is misleading and could have a costly impact on the firm’s financial resources. Income is an accounting term and even though fm is an integral part of the broader realm of an accounting system it is not relevant to a firm’s accrual-basis (fm) financial reports. Income, is relevant only to cash-basis accounting and the cash-basis financial reports are incapable of defining an firm’s true net operating revenue, overhead rate and net profit. The correct term relevant to our earnings as a firm is ‘revenue’, not ‘income’. Revenue does not consider any form of money exchange (incoming or outgoing), just dollars earned or incurred.
respectfully,
Steve L. Wintner, AIA Emeritus
Thanks for that important clarification. That’s what this community is all about. Sharing knowledge and using our collective intelligence to move us all forward.
Hello, I own an Engineering & Survey firm and
am being told by a large Accounting firm that the my “Net Revenue” is calculated as my Gross Sales minus any subcontractors.
I am concerned because I cannot find this description anywhere.
Is this correct for a Professional Service firm?
Hi Paul, the response you received from the accounting firm is only partially correct.
The definition I offer in my book and workshops is as follows:
Net Operating Revenue: The sum of total fees billed and total reimbursable expenses billed, minus the cost to the firm of outside project consultants and all project-related expenses. NOR is the baseline value on the accrual-basis P/L statement—the “100 percent” against which all other P/L Statement values are compared.
Hi Paul, the response you received from the accounting firm is only partially correct.
The definition I offer in my book and workshops is as follows:
Net Operating Revenue: The sum of total fees billed and total reimbursable expenses billed, minus the cost to the firm of outside project consultants and all project-related expenses. NOR is the baseline value on the accrual-basis P/L statement—the “100 percent” against which all other P/L Statement values are compared.