Why Firms’ Revenue Growth Rate Exceeds Their Increase in Profits

Our recently published, 16th annual Rosenberg Survey reports an industry-wide growth in revenues of 6.7%, but a more modest 3.2% increase in income per partner (IPP), CPA firms’ oft-used barometer for firm profitability. At first glance, one might reasonably conclude that firms have been unable to fully translate revenue growth to the bottom line. But this is not the case.

Let’s review the forces at work that artificially hold back average profitability measures:

Mergers currently account for 25% of CPA firms’ growth rates. An increase on the revenue line is immediate, but the increase in profit lags revenue growth because the fruits of the merger typically take from 1-3 years to fully surface.

In almost all mergers, the buyer enjoys higher profitability levels than the seller. Assume that a 7 partner, $8M firm, IPP of $400K, merges in a 2 partner, $1.5M firm with IPP of $300K. In the first year of the merger, the buyer will show a considerable merger-induced revenue increase, but its 9 partners will average $378K, a decrease from their pre-merger IPP.  Has the buyer’s profitability gone down? Of course not. It’s just how the math works.

Many mergers are made primarily to add talent, not necessarily revenues. Lots of talented people work at firms with profitability challenges. Buyers generating organic revenue growth are desperate for people to get the work out. The impact of these type of mergers may initially hold back IPP computations, but there is tremendous upside profit potential.

CPA firms are in the midst of a long-term cycle of Baby Boomer partners reaching traditional retirement ages. When older partners work past 65 at the same time their replacements are promoted to partner, a temporary increase in the partner ranks results.  Again, it’s a math issue, not a profitability matter. An increase in the number of partners artificially lowers the IPP computation.

So, given the above, and the likelihood these scenarios will continue for several years to come, we can expect growth rates to continue exceeding IPP increases. But it’s important to understand that, while the factors discussed above may somewhat hold back AVERAGE income-per-partner, those partners who remain with the firm throughout the mergers and promotions of young partners can fully expect their incomes to rise, both in the short term, and especially, the long term.

Our monograph, What Really Makes CPA Firms Profitable, is updated every year. It’s jammed full of dozens of time-tested, innovative methods and best practices used by the most profitable firms in the country. We’ve just completed the update for 2014 and it’s now available. Take advantage of our generous bulk discounts to give a copy to every one of your partners.