Financial Management

Brian Pinder-Ayres

• Publisher: RIBA Publishing
• Year: 2019
• ISBN:
  9781000701500
• Edition: 1
• Topic: Arquitectura
• Subtopic: Arquitectura general

Most newly qualified architects have scant knowledge about the practicalities of running a practice and in particular the challenges of managing the financial side of the business. This book highlights the major financial risks and how these can be avoided.
The chapters give straightforward advice and practical solutions based on the author's years of hard-won experience. Friendly, clear and concise, it will give you all the knowledge and tools you need to plan for business success.Based on the original Good Practice Guide, this updated and re-designed version is now even more comprehensive and contains detailed information on fees, as well as real life anecdotal advice from practitioners, updated references, and is in line with the latest legislation. This is invaluable reading for sole and small practitioners of architecture and other creative industries.

01
Setting Up in Practice

The decision to set up an architectural practice is a major, and probably life-changing, decision and there are many factors to be considered. This chapter focuses on the financial consequences and significance of the choice of business form. The initial choice you make will have fundamental implications for the practice throughout its lifetime. It will ultimately be of great significance to you or the person who started the business when the time comes to leave or retire.

The chapter also begins to introduce you to the core financial decisions that every practice needs to take.

Choosing the Right form of Business for you

There are three main business structures available to you when you decide to set up a practice:

• Sole trader or partnership
• Limited liability partnership (LLP)
• Limited company (Ltd).

Sole Trader and Partnership

The simplest business form of practice is as a sole trader or as a group of sole traders who form a simple partnership. Each of the individuals involved is self-employed and responsible for their own tax affairs.

All self-employed people have to register with HM Revenue & Customs (HMRC) for self-assessment, which means that they will then have to submit an annual tax return that declares their business profits along with any other taxable income. It is important to register with the tax office within three months of starting to ‘trade’, otherwise a £100 penalty could be applied – which would not be a great way to start your commercial relationship with HMRC.

www.gov.uk/hmrc

For an individual architect starting out on their own, being self-employed is usually the sensible way to begin, because you will have many other things to think about other than the complexities of trading via a limited company or limited liability partnership (LLP).

The great disadvantage of this business form, for architects, is the potentially unlimited personal liability that you’re exposing yourself to. Although you will, of course, have professional indemnity insurance (PII) in place, there are a number of other scenarios under which you could find yourself being successfully sued for a significant amount of money. In these circumstances it would be possible to lose all of your personal assets including your home.

In the past, many architects operated quite happily for years as part of a simple partnership and managed to sleep at night, despite the ‘joint and several’ liability (where each person in a partnership is individually liable to pay back the entire amount of the partnership’s debts or liabilities) which is a key ingredient of this particular form of practice. Sadly, the increasingly litigious world in which we now all live makes this an unacceptably risky model. It is widely known that professionals will have PII, and it is widely assumed that they and their insurers will also have deep pockets. This has made all professional advisers potentially attractive targets for financial claims. It was the solicitors and accountants who made up the profit-sharing ownership of the large multi-national firms that became especially concerned about this issue. They were the ones who led the campaign for the introduction of a new hybrid business model – LLP.

Limited Liability Partnership

In many ways, this business form is an attempt to give the professional practice the best of both worlds. Created by the Limited Liability Partnerships Act 2000, the LLP means that the partnership structure and ethos can be retained, with the addition of the all-important protection of limited liability for its members (partners), which is conveyed by its separate legal entity status. In simple terms, it means that the partners will not all risk losing their homes and other assets in the event of a successful claim against the practice which exceeds the level of their insurance cover.

As a consequence, the vast majority of the top 100 firms of solicitors and accountants have already converted to either LLP or limited company status. Traditionally, it was the fear of facing a very large professional indemnity claim that professional practitioners were most worried about. However, in a recent survey of legal firms that have been through the limited liability conversion process, the reason most commonly cited for conversion was the fear of the potentially unlimited damages that can result from an employment-related claim for unfair dismissal or discrimination.

Unsurprisingly then, this trend has also spread to the other people-based professions and a significant number of architects’ practices have converted to LLPs over the past 15 years. If I were advising a group of architects who were contemplating establishing a new architectural practice today, I would strongly urge them to consider the potential benefits offered by an LLP.

The partners in an LLP continue to be treated for tax purposes as before (i.e. as self-employed individuals), and can carry on with the familiar regime of income tax paid via the self-assessment system. They have to submit a tax return by no later than 31 January following the end of the previous tax year on 5 April.

The LLP as an entity will also have to submit a tax return to reflect the overall profit situation of the business. This ‘Partnership Tax Return’ is used to identify how those profits or losses are shared between the individual partners, and the resulting figures then become the amounts to be entered in relation to partnership profits in each individual partner’s self-assessment tax return.

In this way, partners in an LLP do not need to trouble themselves with the adjustment in thinking that is required by a limited company director, who has to become used to the different timings of the corporation tax regime and the delayed receipt of part of their remuneration in the form of dividends (often paid well after the end of the financial year).

One of the consequences of becoming an LLP is the requirement to file annual financial accounting information at Companies House. This will be the first step into the public domain for many and is sometimes cited as a reason to remain ‘private’ as a sole trader or partnership. Many professionals have been concerned that their peers and staff will be able to see how much (or perhaps even worse, how little) they have been earning. However, Companies House is well aware of these commercial sensitivities, and allows for highly abbreviated accounts information to be filed for all but the largest of companies or LLPs. For most small businesses, and therefore the vast majority of architects, this amounts to a basic Balance Sheet with a few technical notes. This is all that is available to be discovered by the public. In most cases it is very hard to deduce anything meaningful from these figures in terms of how well the practice is doing or how much an individual is earning.

www.gov.uk/companieshouse

As a part of the UK government’s stated aim of reducing ‘red tape’ for small businesses these reporting thresholds are being revised upwards all the time. So the amount of information that is publicly available is set to be reduced even further in future years.

Limited Company

The traditional alternative to working as a sole practitioner or in a partnership is to form a limited company.

As a practice grows in size and the amounts of money at stake become more substantial, a moment tends to be reached when it would make sense to everyone involved to seek the protection of limited personal liability which is provided by the setting up of a separate legal entity. This tends to be an organic process when a level of financial risk is reached at which everyone starts to feel uncomfortable.

The operation of a limited company does involve a degree of extra formality and the need to ensure compliance with the requirements of Companies House and HMRC. Company law has its origins in Victorian times and some of the language and procedures still seem quite antiquated. The Companies Act of 2006 attempted to modernise and simplify a lot of the systems. However, there will always be a price to be paid in terms of disclosure and public reporting, in return for the considerable benefits of limited liability.

Companies House has the task of keeping records on every company on its register so that any creditor or other interested party can find where the company is based, who owns it and the identity of its directors. In order to ensure that this information is kept up to date, Companies House has the power to fine companies for the late submission of information. In extreme cases it has the power to take legal action against individual directors themselves.

Some architects may find it difficult to move from the familiar and informal cultural partnership to the more structured world of the limited company. Hence the appeal of the hybrid LLP described above.

In a limited company the ownership of the practice is reflected in the ownership of its shares. Shares can offer very useful flexibility, because circumstances change over the course of time. For instance, the more senior directors can sell or transfer their shares to the next generation of directors as part of a succession planning programme.

However, dealing with the changes in practice ownership via shares can be fraught with difficulty. Unless you have a shareholders’ agreement in place that deals with all of the eventualities, very difficult issues can arise that revolve around the method used to place a value on the shares held. Very few architectural practices will be publicly listed on the stock exchange, so the value of an individual share becomes a very subjective judgement. The outgoing shareholder will, of course, wish to maximise the value they receive for the shares being sold. Equally, the acquiring shareholders will wish to buy the shares for the lowest possible price. Both parties will agree that a ‘fair’ price should be paid, but this is where the problems can begin, as each has quite different ideas of what a ‘fair’ method of calculation would be.

In order to avoid these problems it is wise to ensure that all new shareholders sign up to an agreement that specifies exactly how shares will change hands, and how the values to be used for this process will be calculated. Therefore it is well worth spending some money on good legal advice in this area, as disputes over shares and succession planning can paralyse the operation of a practice when management attention becomes internalised rather than staying focused on the needs of clients and the wider general market situation of the practice.

It is easy and inexpensive to set up a limited company online these days by following the simple process on the Companies House website. Indeed I often think that you could argue that it is frighteningly easy to do, given the legal and compliance obligations that follow as a result of this decision.

One pitfall to avoid when setting up the company is taking the option of setting up a company that is ‘Limited by Guarantee’. I have known people who have done this, attracted by the idea of some sort of guarantee from Companies House which they assume makes this form of business safer. In fact this type of company is intended for not-for-profit businesses or organisations and is not generally suitable for architects in private practice. If a company Limited by Guarantee is set up it is not possible to transfer it into a company that is owned by shareholders. The initial company will need to be closed down and a new company set up in its place. This will be time consuming and could lead to problems with the use of names.

The Fundamentals of Financial Management

Having decided on the business model that best fits your current needs and future goals, it is essential that you understand the basics of financial management, including how to control ‘working capital’ and how to raise finance to invest in your business.

Control of Working Capital

One of the key tasks in the financial management of a practice is the control of ‘working capital’.

The total amount of money invested in the business is known as the capital. Some of this will be used to provide the permanent fixed assets that are required, such as buildings and vehicles, furniture or computer equipment. The balance goes to provide the funds to pay the staff and all the other day-to-day bills as they fall due. This is the everyday working money and in this book that is what I mean by ‘working capital’.

Definition: Working Capital

Working capital is defined as the value of all current assets less the value of current liabilities.

The terms assets and liabilities are used in the preparation of the annual Balance Sheet, so it is possible to calculate working capital by looking at the most recently prepared set of financial accounts.

Current assets generally include:

• The cash balance at the bank
• The value of money owed to the practice by its customers (the debtors)
• The value of the work completed for which invoices have ...