Adamson Advisory

Profitability

As you manage your accounting practice, sometimes your attention gets diverted to things that might not be as important as others.

Of course, you worry about hiring and retention, partner performance, marketing/sales, facilities and the general reputation of the firm. Lots of time and energy are expended on short-term activities. Maybe it is time to escape the day-to-day and think about what might be good for the firm long-term. When have you really contemplated profitability and the long-term future of your firm?

Profitability is not just about partner salaries. If you are profitable, it enables you to fund future growth of the firm, attract and retain the most talented professionals, explore new services, offer the best technology to your staff and clients, and so on.

If you are not as profitable as you would like, you could simply give up and sell or merge your firm into another firm. Or, you could get larger by growing organically or by being on the acquisition side of a merger.

Many firms are merging as a way to achieve more rapid growth. It helps increase market share and, sometimes, eliminates competition. It also provides more resources to be able to produce products and services to meet the demands of a wider client base.

Keep in mind, a merger is a professional marriage and you need to know your future partner. Take time to look at a merger from all sides and be sure that both sides understand how a combined firm will operate. Involve an experienced outside facilitator. Give me a call if you want to simply discuss your specific situation.

 

Negative WIP and A/R? An Accounting Error or a Best Practice?

 

I am aware of a firm in LEA (the Leading Edge Alliance) that year after year gets questioned for submitting information to the association’s annual survey that surely must be in error. They will remain nameless but the alleged error relates to their outstanding WIP and A/R balances (or the lack thereof). How can their numbers be zero or negative? It’s just not possible. Is it?

Well it is possible and they have jumped ahead of everyone else in terms of cash flow management by a simple but innovative approach to billing their clients. Most of us will cringe but they have a very simple expectation that is outlined in their engagement letters. They bill a third of their audit engagement fees with the signing of the engagement letter, a third at the commencement of field work and a third upon delivery.

So, two thirds of the fee is billed before the work starts? Yes. As you’re reading this you’re thinking “no way that my clients are going to buy that”! Well, it didn’t happen overnight for this firm and they will be the first to admit that not every single client does it. But what impact would it have to your cash flow if half of your clients did?

The firm that I am talking about has been implementing this (educating their clients) for several years and they have sold it. For instance they have used it as an alternative to raising fees (when they probably would not have raised them anyway) during the recession. It doesn’t happen over night and acceptance will be gradual. Remember I said that they bill it sooner than most of us. Collecting it is where they have eased into it.

Other firms use a similar approach with tax returns where they expect half or in some cases all of the fee with the engagement letter. Do they demand it or do they expect it? There is a difference.

There is absolutely no reason that you cannot implement something similar in your practice. The results will be significant and if you manage it well, over time you will migrate your clients with very little if any attrition.

 

 

Average Billing Rate Per Hour in CPA Firm Mergers

I have had several questions regarding my November 11 blog post entitled Five Merger Tips to Help You Seal the Deal. They have centered around my comments on the average billing rate per hour and how that should be one of the early litmus tests in looking at the target firm in a merger.

The question is if the target firm’s partner rates are quite a bit lower than those of your firm, does that mean that it is not going to be a good fit? No – not necessarily. If, for instance, the partners of the target firm are doing a lot of the work, they are going to be retiring soon as a part of the deal with you and you can replace many of their hours with staff hours, then it may very well work. If on the other hand in this example they are staying with you after the merger, think about the two cultures and whether the way they practice is compatible with you.

Remember, my point about comparing average billing rates per hour is for the entire firm, not just the partners. You have to use that indicator as a starting point and get underneath the numbers to understand how you really compare.

The key point  holds true. If there is a big difference between the average billing rates of both firms, you need to dig into it soon in the discussions.

Making Money in CPA Firms – Follow Up

In my last blog post we talked about the 2010 Rosenberg survey and that his “Elite” firms enjoyed both a significantly higher leverage ratio and overall net firm billing rate than the rest of the firms in the survey. We also gave you several factors that influence average rate per hour beyond the billing rates themselves.
Here are some things that you can work on in your firm that will help you make incremental improvements to your net firm billing rate and ultimately the profitability of your firm.

  • Billing Rates. Make sure that you keep upward pressure on them even in this economy. It really is true that the more mud you throw at the wall, the more that will stick. If your realization rate is in the upper 80% range or higher, you need to raise your rates.
  • Efficiency. When was the last time that you looked at your work programs, job flow, supervision and review processes, the use (or misuse) of your technology, job scheduling, communication/interaction with your clients, etc. Odds are it’s been awhile. Remember that deep down we’re all auditors and the tendency is to fill up the files with procedures and “stuff” that we don’t need, regardless of the level of work that we are being paid to do. Talk to the team – ask them for efficiency suggestions. If it’s been awhile since you’ve had AuditWatch come in to re-engineer your work files, call them.
  • Scope Creep. Address this in a couple of different ways. First, make sure that the client is ready before you start the job. If you show up and they aren’t, stick to your guns and pull off until they are. Second, educate your staff to know when they are out of scope and to get change orders from the client when they are.
  • Who are the billers and what are their billing philosophies? You know who your conservative billers are and who the aggressive ones are. It’s not necessarily about who is doing the fixed fee audit work vs. the higher value consulting. Every partner should have improving their overall realization percentage as one of their goals You can’t expect everyone to be the same; that’s why improvement goals are the way to go. Also, don’t be afraid to “help” some of your more conservative billers by having a more aggressive biller review their billings to challenge write downs and offer suggestions.

 

Making Money in CPA Firms in These Turbulent Economic Times

The universal measure of profitability in accounting firms is average income per partner. Another universal tool is the annual Rosenberg National MAP Survey which I am going to draw from for this blog post. The 2011 edition comes out in September – it’s a must have for running your firm.

In the 2010 survey, Rosenberg identifies his “Elite” firms which are the 54 who had income per partner of over $500,000. Not bad considering it is based on 2009 economic data in the middle of the recession. It’s interesting if you dig into the data in the survey you will find that these 54 aren’t just the biggest firms although as Rosenberg puts it, bigger is better in terms of profitability. In fact 24 of them are in the $2-$10 million fee range and three are sole proprietors.

I want to focus on two measures in the survey where the most profitable firms really make their money: partner to staff leverage and overall net firm billing rate. The 54 top firms had a leverage ratio of 7.7 to 1 compared to 4.9 to 1 for all 425 firms in the survey. Wow! The net firm billing rate for the top 54 was $157.80 versus $136.63 for all firms. Remember that the overall survey averages include the top 54 which means the gap between them and everybody else is actually wider.

The leverage ratio which is also illustrated by net fees per partner is pretty easy to understand. Clearly the fewer owners that you need to service a given amount of client revenue, the more you will earn per partner. The top 54 firms have figured out how to do that. As a managing partner, this is not a statistic that is easy to change but it should always be on your radar screen and it has the most significant impact.

When most of us think about the second statistic, overall net firm billing rate, we automatically jump to the assumption that the most profitable firms have the highest billing rates and “we can’t get there because we just can’t raise our rates that much”. Not so fast. The Rosenberg survey included 40 firms with over $20 million in revenue and the average partner billing rate for those firms was $356. The average partner billing rate for the top 54 was only $324. So what else is going on with those top 54 firms?

The answer is that a firm’s billing rates are only part of the equation. The net billing rate is a mathematical expression for a number of things happening in you firm. Yes, it is total billings divided by total charge hours. But how do you maximize the billing number and minimize the hours? All of these factors are part of it:

  • Billing rates
  • Mix of staff on the job (proper leverage)
  • Efficiency – use of the firm’s technology, efficient work processes and review, minimizing stops and restarts, etc.
  • Scope creep – are you controlling it and getting paid for it?
  • Type of work – audit vs. tax vs. consulting. Are you billing what the market will support?
  • Fixed fee?
  • Work budgets
  • Who are the billers and what are their billing philosophies?

All of these have an impact on your net firm billing rate. As managing partners we should be looking at all of these and ways to make incremental improvements. If we do, it can add up to significant strides in improving our overall net firm billing rate and the ultimate goal, our average income per partner.