Accounting Firm Profitability
This is the fourth in a series of editorials by Results Accountants' Systems.
Accounting businesses are mature industry. There is intense competition for clients which is typical when the principal services offered in the industry have a very generic look and feel about them. Clients are able to drive prices down because switching costs are relatively low.
Accounting firms have very similar cost structures to their intra-industry competitors. Again, this is typical of any business in a mature industry. They utilize essentially the same technology and hire the same type of people at more or less the same level of compensation, they occupy similar types of accommodation, and they consume the same variable inputs. There is little evidence that significant economies of scale apply in the industry (with one glaring, and extremely significant, exception). In fact, many small firms yield significantly higher returns to partners than most large firms.
The one significant exception to the general observation that there are limited economies of scale relates to the issue of cumulative experience. In comparison with smaller firms, larger firms have more people with varied experiential backgrounds. Therefore they have available (but often under-utilized) more intellectual capital to draw on. They also have far more precedent files that they can access to benefit from the learning curve phenomenon. This can give larger firms a decisive competitive advantage but it is mitigated to a large extent by the fact that they tend not to drive home the opportunities they have.
As technology facilitates faster and more efficient processes for capturing and accessing past experience, we believe that larger firms are going to increasingly use this competitive weapon to build market share and client loyalty through being able to create more value at a lower cost. Smaller firms will have to be able to match this. The only way they will be able to do that is to join a strong knowledge focused international network that allows cross sharing of information, knowledge, and experience. A classic example of this sort of network is the Results Accountants’ Network – which is the largest network of its kind in the world.
Given that the cost structure of competing accounting businesses is similar, and given that there is therefore limited scope for firm profitability to be increased by reducing costs, it is obvious the focus needs to be on the revenue side of the equation.
Traditionally, firms have subscribed to the view that to build revenue you need to get more clients and offer them the same services you offer to your existing clients. This might work when the population of clients is growing rapidly but it does not work in any other situation. Inevitably it leads to under-price, over-promise marketing and service strategies, high levels of client defection and consequential low levels of firm profitability. It is also arguable that this predatory marketing focus detrimentally affects the market position of the profession as a whole.
To improve profitability it is necessary to identify the things that ultimately drive it. These may be described as the critical success factors, which can be managed. One way to look at revenue that produces some useful insights is to see it as the number of hours a firm has available to sell multiplied by its productivity multiplied by the average realization rate.
The number of hours available is determined by the number of people multiplied by the time they have available. Productivity is measured by hours charged to work in progress. This rate reflects the firm’s pricing decision. In very simple terms therefore, increasing the number of people, increasing the time they have available, improving productivity and/or increasing prices can increase revenue. The cost of operations is the other side of the equation and this can be broken down into team compensation costs, variable operating costs and fixed operating costs.
The model embodied in our software application “integrate” takes revenue and cost drivers into account. It may be summarized as follows:
Profit per partner equals:
The total number of people in the firm divided by the number of equity partners
Multiplied by time available per person which equals:
Total hours available from all people divided by the total number of people in the firm
Multiplied by hourly productivity which equals:
The number of hours charged to WIP divided by total hours available from all people multiplied by the actual targeted yield per hour which equals:
The targeted value of time charged to WIP before write-ups and write-downs divided by the number of hours charged to WIP multiplied by a disbursement scaling factor which equals
Total WIP before write-ups and write-downs
The targeted value of time charged to WIP before write-ups and write-downs
Multiplied by the value index which equals:
Total WIP after write-ups and write-downs divided by total WIP before write-ups and write-downs multiplied by the billing index which equals:
Net fees billed to clients divided by total WIP after write-ups and write-downs
Multiplied by the net profit margin which equals:
Net profit divided by net fees billed to clients
When you cancel out all the common terms in this equation you end up with:
Net profit divided by the number of equity partners
These and other concepts are embodied in various RAS systems and resources.
By Ric Payne
Results Accountants’ Systems
Results Accountants' Systems improves the profitability and performance of Accounting Firms around the world. Beginning with its revolutionary Accountants Boot Camp experience, RAS enables CPA firms to develop and deliver practice-proven consulting and advisory services while creating dynamic, stimulating professional environments. RAS systems and support provide firms with the products and the people that differentiate them from the competition.
From its inception in Western Australia in 1992, RAS has been a leading force for changing the accounting profession, moving firms from compliance work into value-added consulting services. In the process, RAS has grown into a multinational organization, launching successful operations in North America and Europe. Nearly 3500 firms worldwide have taken advantage of the RAS systems and the Results Accountants' Network to increase profits and invigorate their practices. For information on the latest tools and resources to improve your firm's performance, call Results Accountants' Systems at 1 800 800 5601, or visit the RAS website at www.ras-net.com.