four ways to increase revenue. four reasons that employees should care.
by marc rosenberg
how to bring in new partners
future cpa firm leaders must have an understanding of how their firm operates as a business, including how it makes money and what holds back profitability. with this knowledge, team members will make better decisions about how they spend their time and perform their work.
more: public accounting as a business, 101 | nuts and bolts of mentoring staff | nine ways to measure staff performance on the path to partner | sixteen duties of a partner | five people to keep out of partnership
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all businesses have economic structures unique to their industries:
- grocery stores are high volume, low profit margin.
- real estate ventures use accelerated depreciation and other tax angles to generate cash flow and healthy rois.
- professional sports teams focus on increasing the value of the franchise so it can eventually be sold for a gigantic profit.
the typical cpa firm is a low-volume, high-priced business, with a relatively high profit margin (generally 30-45 percent of revenue).
- the supply of cpas relative to the demand for them is fairly low. this is because of the high level of technical knowledge required to become a cpa and a long-time decline in the popularity of a career in accounting. most young people do not perceive the accounting profession as exciting. the result is a shortage of labor. this has led to firms operating at lower volumes than they would prefer, but it puts them in a position of charging strong prices.
- cpa firms enjoy their high profit margin because of a few interrelated factors. first, because of a shortage of staff at the senior and manager levels, partners are forced to perform more billable client work than they would like to or should do. second, many cpa firm partners enjoy doing work that other firms would delegate to staff, which partly accounts for their lofty billable hours (often 1,200 to 1,400). third, many cpa firm partners feel that a good way to increase their compensation is to work harder themselves and employ fewer staff.
the vast majority of a cpa firm’s revenue is considered “annuity” business. clients of cpa firms typically remain with their firms for five to 10 years or more, thereby providing a relatively safe revenue stream that continues every year, primarily for compliance projects such as audits, reviews, compilations, bookkeeping and tax returns.
most expenses are fixed. even though staff labor is theoretically a variable cost, with the exception of major recessions the head count at firms stays relatively constant despite fluctuations in revenue. most firms can absorb a healthy number of new clients without increasing their personnel head count.
also, because of the shortage of labor, most cpa firms are continuously in a hiring mode: if a firm is fortunate enough to come across someone who has a good resume and is available, the person will generally be hired immediately, even if the firm’s revenue volume does not appear to justify increasing head count.
low overhead expenses. cpa firms have low overheads compared to law firms and other businesses. despite earning substantial profits, the vast majority of cpa firms are not big spenders. many have very nice offices but would never be considered lavish. a very small percentage of a cpa firm’s expenses are discretionary.
cpa firms are top line-driven. in the pursuit of increased profitability, many businesses must either increase revenues or decrease expenses. but cpa firms rarely focus on controlling expenses because there is little excess to trim. instead, virtually all focus is on increasing revenues.
cpa firms increase revenues by
- bringing in new business and clients.
- increasing billing rates.
- increasing realization, billing a higher percentage of time spent on client work.
- increasing productivity, getting personnel to bill more hours and work more efficiently.
increases in revenue drop directly to the bottom line (profits) because these revenue increases rarely cause the firm’s expenses to rise much.
leverage is king. the vast majority of the work performed by a cpa firm is done by staff instead of partners. therefore, one of the top operating strategies of firms is to maximize the amount of client work that each partner can create for nonpartners to perform, under their supervision. achieving this high leverage frees up partners’ time to devote to developing business, nurturing relationships with clients and referral sources and helping staff learn and grow.
bigger is better. any analysis of cpa firm profitability will consistently and conclusively show that the higher a firm’s revenues, the higher its profits will be. this is because the bigger the firm, the more it can afford to invest in sophisticated marketing programs, develop specialties and niches, aggressively pursue mergers, create better training programs and hire high-level professionals in the administrative, marketing, hr and it areas. all of these tactics attract larger clients (who pay higher fees), more talented staff and smaller firms looking to merge in.
why should employees care how the firm makes money?
the cynics among you might ask this question. after all, the profits that the firm earns from the staff’s great work go directly into the partners’ pockets, right?
what incentive do staff have to contribute to firm profitability? what’s in it for them? here are four good reasons:
- some of the profits flow directly to the staff in the form of higher salaries and bonuses. high levels of compensation enable the firm to retain its best people.
- more money is available for career-enhancing training programs, updated technology, top-notch marketing and other niceties such as modern (not lavish) offices.
- capital is available to merge in smaller firms and attract larger and more sophisticated clients, creating new client opportunities for everyone, including the staff.
- when a company’s revenues and profits are increasing, a funny thing happens to office morale: everyone is happier! firm personnel are more fun to be with, more helpful and more willing to work together. bosses are more patient and smile more often.
the opposite of all those things happens when companies struggle. ask anyone who has had the misfortune of working for a stagnant organization that struggles with profitability. it can be miserable.
key definitions
charge hours or billable hours. a cpa firm’s widgets (units of production) are hours. the vast majority of a firm’s revenue is billed directly or indirectly by the hour, so cpa firms pay a lot of attention to the billable hours worked by their personnel.
non-charge or nonbillable hours. all work time that is not worked on client projects. this includes training, firm meetings, business development, vacation, holiday and sick time.
billing rate. all personnel, from partner to staff, are assigned standard hourly billing rates. these rates, when multiplied by the hours worked on client work, result in a number called gross fees or billable time, which eventually is billed to clients.
timesheet. all charge and non-charge hours are recorded on timesheets. these charge hours are entered into the firm’s billing system and accumulate in the firm’s work-in-process, which is the starting point for generating client invoices.
work-in-process (wip). wip is a receptacle in the time and billing system where all time and expenses are accumulated by client. when clients are billed part or all of the accumulated wip, these billings reduce the wip balances, leaving a net unbilled amount for each client. these amounts are either carried forward to subsequent months to be billed at a later date or written off.
write-offs. cpa firms (law firms, too) are rarely able to bill for 100 percent of their actual time spent on client work. the amount of client work that is not billed to clients is written off. the vast majority of firms write off 10-20 percent of their client time.
there are many reasons for write-offs, including:
- project inefficiencies that cannot be passed on to clients
- discounts given to clients to procure the engagement
- on-the-job training. experienced personnel often use client engagements to teach less experienced staff how to perform their work. this training often cannot be billed to clients.
realization percentage. the percentage of all client work that is billed to clients. the realization percentage for most cpa firms is in the 80-90 percent range.
billings are the actual amount of billable time that is invoiced to clients. the difference between gross fees (the value of all time worked on client projects) and billings (sometimes called net fees or net revenues) is write-offs.
leverage. this term is used in many industries and has a different meaning in each of them. in cpa firms, there are two interrelated ways to define leverage:
- a partner delegating client work to a staff person. the more staff that each partner can keep busy with client work, the more the firm is considered leveraged.
- leverage is measured as follows: if a firm has five equity partners and 25 professional staff (administrative staff are not included in the leverage computation), the staff-partner ratio is 5:1. staff-partner ratio is a principal way that cpa firms measure leverage.
income per partner. the total earnings of all equity partners divided by the total number of equity partners. ipp is the primary measure of a cpa firm’s profitability.