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Feb 1989

Improving firm profitability. (accounting firms) (adapted from The Practice Development Institute Report, Oct. 1988)

    Abstract- CPA firms must be involved in more activities than simply handling clients in order to increase profits; good management is essential, and everyone in the firm must sell, innovate, motivate, train, and lead. Profitability can be innovatively improved through job control systems that minimize work-in-process writeoffs, by linking performance to compensation, and by implementing value billing rather than charging an hourly rate. Traditional methods of improving the bottom line, such as setting billing rates aggressively, planning well in advance, and leveraging time should not be overlooked.

Many CPA firms are reporting profitability levels that are, at best, in a holding pattern. Indeed, many are seeing declining profits.

Why are CPA Firm Profits Stagnating?

The basic issue is one of CPA firms coming to grips with the need to run their practices like other businesses. Think about the factors that enable a "normal business" to be successful: selling, new product development, management, people development. Most CPA firm partners are not trained or experienced in these areas, and they are unwilling to devote time to them.

Prior to the early 1980s, if a CPA was a competent technician and had some contacts, he or she could hang out a shingle and be reasonably successful. Such is not the case today. Many internal and external changes have taken place in the CPA profession, which make it much more difficult to build a successful practice. Here are some of the major reasons: . Greater competition is causing firms to fight harder to get new business and to keep their clients from being stolen by aggressive competitors. Getting new business requires proactive, direct marketing efforts; the passive approach doesn't work anymore. . Clients need more from their CPAs than audits and tax returns. They need help managing their businesses. The market for consulting and advisory services is growing much faster than the accounting/tax market. Futurists tell us that 10 years from now, 50% of our practices will consist of services we are not offering presently. Product and services innovation is vital if a firm expects to meet the increasingly sophisticated needs of the client. . CPA firms are notoriously weak at dealing with their people. The nature of our work created the famous "pyramid" structure, which limited promotional opportunities.

Today, firms are starting to realize how important it is to develop an effective staff that is loyal and stable. But this can be expensive both in terms of management time and education costs. . It used to be that the only significant cost was labor. Now the costs of liability insurance, marketing, computers, and telecommunications equipment have eaten into the profit base of most CPA firms. . Finally, it takes good management to address all of these issues. A firm needs a plan, a vision. Management must hold people accountable for making it happen and motivate all firm personnel, from partners to clerical, to be productive. Then it must tie compensation to results. Today's CPA has to be involved in a lot more activities than simply handling the clients.

The best solution is a commitment to management. What's really going to make the difference is good management. The managing partner and the management team must be effective at getting everyone in the firm to sell, innovate, motivate, train, and lead. This may mean that those members of the management team with client service responsibilities may need to reduce their billable hours to spend more time in management. If they are effective managers, the increased productivity of those they manage will more than offset their own reduction in billable hours.

In addition to the management issue, there are other approaches to improving firm profitability that seem to be successful today. First, there's an area called job control. One of the biggest controllable expense items on a CPA firm's income statement is writedowns of standard fees, sometimes referred to as work-in-process (WIP) write-offs. Yet there is very little that CPAs can do to attack this problem aggressively. A job control system is designed to detect and minimize WIP write-offs before they occur or get out of hand. This is achieved with a system for monitoring and controlling jobs in progress.

Second, more firms are implementing programs that link performance to compensation for partners. It's important to hold people accountable for the achievement of their goals. One of the best ways to do this is with compensation. Management by Objectives (MBO), profit center reporting, and collections are three common programs utilizing performance linked compensation methods.

Third, there's the area of value billing. Get away from the hours- times-rate mindset and look carefully at the value of the services provided and bill on that basis. There's a tremendous payoff to a firm that's successful at value billing, because each incremental dollar billed falls directly to the bottom line.

Fourth, another area of opportunity is a throwback to conventional business procedures. Instead of rushing to get your client bills out as fast as possible, take an additional day to give your senior people a chance to review and challenge the bills. Let them take the time to review why WIP was written off or carried forward to the next month. Make sure you've identified all value billing opportunities.

A final area to explore is billing of internal costs through WIP. Many firms have adopted procedures for processing basics such as travel costs, telephone and tax processing fees through WIP. But many areas are still ignored--secretarial time, employee allowances, scheduling and quality control time, office supplies, liability insurance, interest, and many others. All expenses incurred on behalf of the client should be billed.

Some basic traditional methods of improving the bottom line are also being overlooked by firms today. For example: . Billing rates should be set aggressively. Always err on the side of the rates being too high instead of too low. In particular, pay close attention to the development of your staff. The talented people may be developing client handling skills at a pace that exceeds their billing rate increases. . Keeping your staff occupied today requires lots of planning months in advance. Each person's billable time should be monitored continually to maximize his or her productivity. . Leveraging your time is important. The higher the number of people that a partner has working for him at the same time, the more profitable the firm will be. It may be much more productive if a parner spends 10 hours planning a $20,000 audit than for the partner to do 10 hours of billable work. . A simple chore like filling out a timesheet properly can add profits to the bottom line. Techniques such as rounding time to the nearest tenth of an hour and daily time reporting are just two of the many ways to capture billable time that otherwise can fall through the cracks.

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