Keys to CPA Firm Profitability: Don’t Ask a Partner

If you asked the president of a Fortune 500 company or the owner of a small business to define profitability, a quick and easy response would follow.  Not so with CPA firms.  One would think that the undisputed champions of measuring financial data – CPAs – would be capable of defining their own firms’ profitability.  Not by a longshot.

Here are several keys to profitability that typical, local firms often overlook.

Overreliance on partner income percentage as a measure of profitability. Firms are much better off measuring profitability by income per equity partner.  Here’s why.

Partner income percentage is impacted much more by staff-partner ratio than by innate profitability.   Many partners have a rule of thumb that 33% is an acceptable partner income percentage, and that to be truly profitable, 40% or more should be the target.  But data from The Rosenberg Survey refutes this.  Firms in our survey with a staff-partner ratio in excess of 8:1 earned $491,000, yet posted a partner income percentage of “only” 23%.  Firms with staff-partner ratios under 4:1 earned $260,000 per partner while posting a 39% partner income percentage.  It’s pretty clear which group is more profitable, despite the former’s  23% partner income percentage to the latter’s 39%.

Never be content with “average”

Remember, when a MAP survey cites an average metric, it’s just that – an average. To illustrate, let’s examine annual billable hours for staff. If the national average is 1,530 and you’re firm is at 1,530, you have little cause for celebration because your performance is perfectly average. But 175 of the 400 firms in The Rosenberg Survey did better than your firm! The goal should be to achieve results well above average in as many categories as possible instead of being merely average.

Realization

When realization is at or near 100%, this usually means a firm is leaving money on the table because their billing rates are too low.  Different clients have different levels of fee tolerance.  Some pay whatever you bill and others complain about fees and force discounted billings. Realization rates in the mid to upper 80s is where most firms should be.

Short-term vs. long-term thinking

The most recent Rosenberg MAP Survey showed average income per partner of $392,000.  If firms were only interested in maximizing short-term profits, this figure would probably be in the $450,000 to $500,000 range.  Maximizing short-term profits to the detriment of long-term success is tempting but misguided.  Here are some things firms do to maximize short-term profits:  (a) partners doing staff level work and working high billable hours, (b) little investment in their people by underpaying staff and failing to invest in training and mentoring, (c) making do with archaic technology and (d) low spending levels on marketing.  Smart firms understand that investing in the firm today yields increased profits tomorrow.

Our book What Really Makes CPA Firms Profitable? addresses ►the essence of CPA firm profitability, ►benchmarking, ►marketing and the bottom line, ►strong management and leadership: the most reliable path to profitability,  ►25 best practices that move firms from good to great, ►what does not seem to be important to firm profitability, ►partner relations: happy partners are productive partners and ►40 great ways to improve CPA firm profitability.

What “being profitable” means

Of all people, CPAs understand the value of comparing actual financial results to budget.  They see their larger, well-managed clients do it all the time.  But typical local firms almost never prepare budgets.

Two fundamental ways of benchmarking profitability are to compare actual profits:  (a) to budget and equally important, to (b) what the partners wish to earn (two different, albeit related measures).  Too frequently, firms fall into the trap of avoiding budgeting because they see little value in it.  Instead, they think:  “Gosh, the most my father ever earned was $80,000 and my income is $400,000 – way more than I ever thought I would earn.  Life is good.  Who needs budgeting?”

Benchmarking

There are dozens of metrics that collectively have a direct impact on profitability.  Examples:revenue per partner and per person, leverage, realization, billable hours per person, billing rates, etc.  One cannot analyze profitability by simply looking at income per partner.  We need to understand the underlying factors that produced the profits.

The “big 4” profitability metrics

For nearly 20 years, The Rosenberg Survey has spent hundreds of hours analyzing CPA firm performance metrics.  The results of this analysis conclusively prove – every year – that four metrics stand out from all others in their correlation with the highest levels of profitability.  They are revenue per partner, revenue per person, staff-to-partner ratio and partner billing rate.  If firms do nothing else, they should analyze how they stack up for these four metrics and more importantly, execute a game plan to improve performance in each of these areas.

The fastest path to profitability has little to do with classic performance metrics.

Tactics for achieving profitability nirvana include (a) strong management and leadership, (b) attaining partner accountability, (c) executing an effective plan for growth, (d) treating staff at least as important as clients while making the firm a great place to work and (e) having a partner group that works well as a team and adheres to the firm’s core values.