CPA Firm Success Metrics: Understanding Practice Economics · 2016. 11. 2. · the reasons and need for CPA firm success metrics •Then, we’ll gain a deeper understanding of the

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CPA Firm Success Metrics: Understanding Practice Economics

Facilitated by:

Jack G. Lee III, CPA

November 3, 2016



Poll #1

• What answer best characterizes your reason for attending this web seminar?

– To improve my personal knowledge of firm metrics

– To get better at explaining firm metrics to others

– To understand what metrics are right for my firm

– To recognize the risk of misunderstanding firm metrics

– All of the above

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Our Agenda

• First we’ll address the question “Why Measure?” and explore the reasons and need for CPA firm success metrics

• Then, we’ll gain a deeper understanding of the five key metrics that drive net income per partner (NIPP), including leverage, utilization, gross billing rates, realization and margin. In our discussion, we’ll: – Explain how each metric is computed and how the metrics integrate

– Review the risks associated with misunderstanding or overemphasizing a particular metric, and the need to benchmark your firm’s metrics with other firms to know how well you are doing

– Discuss the relative “importance” of each these elements of firm profitability, and ways to improve each metrics as you seek to lead and manage your people and engagements

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Why Measure?

4



The Leadership Development Model

Establish Unity

Around Firm Strategy

Define Performance– Roles and

Goals

Monitor Performance – Return and

Report

Evaluate and Discuss

Performance

Reward Performance

Ownership

Accountability Trust

CPA success metrics are used to set goals and

monitor, evaluate and reward performance

5



But Be Careful!

• Some measurement missteps we see include: – Measuring too many factors so people are unsure as to which

one to focus on or are able to pick and choose which ones they’ll care most about

– Overemphasizing a particular metric in a way which drives unintended behavior or results

– Not understanding the things that influence measures, so misinterpreting your statistics

– Not paying attention to your own measures or not being committed to contributing more than you receive

– Manipulating measures aimed at “looking good” while not actually “doing good”

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Big Picture: It Isn’t All About Numbers!

• Let’s not lose sight of the most important measures!

– Are you happy?

– Do you enjoy your work?

– Are your people fulfilled?

– Are you making a difference for others?

– Do you want to come to work each day?

– Are you challenged and growing?

– Are you challenging and growing others?

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“A true measure of your worth includes all

the benefits others have gained from your success.”

Cullen Hightower

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What Should We Measure And What Do The Measures Mean?

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The Data Gatherers

• 2016 Inside Public Accounting Annual Survey and Analysis of Firms – www.insidepublicaccounting.com

• The 2016 Rosenberg Map Survey – http://www.rosenbergsurvey.com/

• AICPA PCPS/TSCPA National MAP Survey - 2016 – www.aicpa.org/pcps

These aren’t always apples-to-apples, so you have to know what you’re looking at to do valid comparisons!

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The Most Important Financial Measure

• Let’s first focus on the most important financial measure of all Firm revenue – Firm expenses ⁼ Net profit

• If your firm, department, or engagement is making money overall, something is likely to be going well

• But it doesn’t mean things are perfect – You could be short-staffed, skimping on important investments like

training, mentoring, succession planning, etc.

• But, it is still important to keep your eye on the “big prize” while measuring and managing the “small stuff”

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“The trouble with measurement is

its seeming simplicity.”

Author Unknown

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What The Experts Say

• According to the 2016 Benchmarking Surveys, the most important factors affecting Net Income Per Partner (NIPP) are: – The 2016 IPA Annual Survey and Analysis of Firms (Based on data

from 2015) • Leverage (ratio of staff to partner)

• Utilization (ratio of charge hours to total hours)

• Billing rates

– The Rosenberg 2016 Survey (also based on 2015 data) • Leverage (ratio of staff to partner)

• Margin

• Billing rates

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The Maister Formula

• According to David Maister, respected consultant to the professional services industry and author of Managing the Professional Services Firm, NIPP can be analyzed and better understood by the following formula: – Leverage x Utilization x Billing Rate x Realization x Margin = NIPP

• This formula is sometimes referred to by the acronym “LUBRM” – pronounced “Lubrum”

• We will refer to often this formula as we explore and go deeper on each of the five key CPA firm success metrics

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Poll #2

– Leverage

– Utilization

– Billing Rates

– Realization

– Other

Before “diving in,” what do you think is the most important CPA success metric? (Select one)

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NIPP

• Net Income Per Partner (NIPP)/owners an important measure computed by dividing net income by the total number of partners, typically equity partners

• The computation of NIPP allows comparison of firms of all sizes, however you need to be careful when drawing comparisons

– For example, if partner “salaries” or draws are taken out at the expense line, then NIPP is what the partners accrue IN ADDITION to their draws, so partner compensation is a combination of the two

• As benchmarking shows, larger firms have higher NIPP than smaller firms, typically due to higher leverage and higher billing rates

• For many firms, NIPP is growing at a slower rate than revenue, indicating an ongoing “investment” in staffing and new partner admissions as “Boomers” near retirement

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NIPP Benchmarking

Leverage x Utilization x Billing Rate x Realization x Margin = NIPP

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Leverage Defined

• Leverage is typically calculated as the number of billable professional staff divided by the number of equity partners

• Sometimes leverage is calculated as a function of billable hours – For example, if you have 3 accountants who billed a total of 140 hours

together on a job and 1 partner who billed 38 hours on that same job, your leverage is 3.0 based on headcount or 3.7 based on hours

– Other “leverage” type measures used include fees per professional or per person

• Generally, higher leverage often correlates to higher NIPP, but higher leverage can also be a cause of lower realization

• Leverage ranges from 2 professionals per equity partner for the smallest CPA firms to almost 11 professionals per equity partner for the largest, with leverage for mid-size firms ranging from 7 to 9


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Leverage Example

With Leverage • Engagement estimated at 10-12

hours, sold for $3,500

• Partner delegates:

– Management and final deliverable review of 4 hours to a manager at a rate of $220 ($880)

– Data gathering, analysis and deliverable production of 6 hours to a senior at $125 hour ($750)

– Works 2 hours at various points on the project at $400 hour ($800)

– Total billable time incurred is $2,430

– Write up is $1,070

With Less Leverage • Engagement estimated at 10-12

hours, sold for $3,500

• Partner feels only she and a manager can and should do the work

• The work is completed as follows:

– Partner does management, final deliverable review and various points of client contact for 7 hours at a rate of $400 ($2,800)

– Data gathering, analysis and deliverable production of 5 hours to the manager at $220 hour ($1,100)

– Total billable time incurred is $3,900

– Write-off of $400

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Leverage Is Key

• People are your #1 asset, not only for serving clients but for firm sustainability and building the CPA firm of the future

• We believe leverage is the most important of the five key success metrics

– Without the right quantity and quality of people, CPA firms cannot grow and thrive

• Increase your focus on leverage by: – Continually recruiting new and experienced hires

– Creating effective new hire orientation programs and written role descriptions

– Developing your people through formal learning and shadowing programs

– Focusing on retention efforts

– Delegating ownership and developing succession plans

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Leverage Trade Offs

• The trade offs of leverage include: – More leverage means more teaching, more corrections, more

“re-do” as people come along and are developed – this often results in lower realization in the short run but will pay “dividends” in the long run in terms of succession, more partner time for business development, and even retention

– Less leverage means less high level talent time spent on business development, practice management, client relationships and people development

• Don’t let Partners and managers be seen as hoarders or bottlenecks

• Or the younger, less experienced people will feel stifled, not valued, or not challenged

• And retention / succession planning are likely to be challenging

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Leverage Benchmarking


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Poll #3

• Why don’t we leverage more to other team members? (Select One)

– Think we can do it faster/better so what’s the benefit

– Don’t want to take the time to teach / instruct

– Afraid of time on the back end for “cleaning it up”

– I would delegate more but resources are too scarce

– Other

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Utilization and Chargeability

• Calculated as total charge hours divided by total work hours

– For example, if you charge 1,350 hours and you work 2,200 total hours, your utilization is 61.4%

• Utilization represents the level of “effort” put forth by its chargeable professional resources

– A higher utilization percentage can be a “real time” indicator the firm is on track financially

– A lower percentage may mean you have excess capacity or too many people for the amount of work available

• In the “LUBRM” formula, utilization is expressed in terms of average chargeable hours per billable professional, rather than as a utilization percentage


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Utilization “Reducers”

• When utilization is down, the main drivers include:

– A lack of work sold – in most firms, during poor economic times, audit utilization has been down

– Poor scheduling or someone being on the “do not use” list and being passed over for work

– Team members with skills that don’t match the work sold

– Billable resources not making billable work a priority or taking the initiative to have their plate full of billable work

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Utilization “Inflators”

• While staff utilization can be an indicator of on track financial performance, in can also give a false reading

• The things that can falsely “inflate” utilization, and make it “look better” than it is, include:

– Hoarding work, especially when a partner or manager who controls work flow to make their numbers look better

– Over-worked “MVP” resources whose numbers look great, but there may be frustration or “burn out” that’s building

– A lower total number of hours worked comparatively, so the utilization percentage is high but the overall effort is off

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Utilization Importance

• Recognize that the expectation of both high utilization and high realization can be unrealistic and discouraging to staff

• Recognize also that the concept of utilization is increasingly “old school,” and that a “deliverables” based, work anywhere, anytime environment is the direction for the firm of the future

• To reduce reliance on utilization as a management tool in the changing CPA work environment:

– Make sure there is clarity on ownership of clients, engagements, projects

– Delegate effectively, being clear on deliverables, by-when dates, and return and report procedures

– Teach effective time management skills, including the weekly update of WTD or “back log” reports by-when dates, setting / resetting expectations

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Utilization Benchmarking


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Chargeability Benchmarking

• Many firms may not focus as much on personal utilization percentages, but instead on a number of charge hours per person or by level

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Poll #4

• What is a potential negative consequence of over-emphasizing utilization? – Team members padding their timesheets

– Higher level employees hoarding billable work

– Staff development and business development being de-emphasized

– Staff feeling discouraged because their leaders “don’t get it”

– All of the above

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Billing Rates

• According to David Maister in Managing the Professional Service Firm, increasing billing rates (“raising prices”), is the number one way to improve CPA firm profits

• Increasing billing rates is an amazing “lever” that can drive profit to the bottom line without hiring another professional, adding another client or selling another engagement

• In addition, benchmarking shows that firms with the highest partner and staff billing rates also have the highest profits and NIPP


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Increasing Billing Rates

• For most CPAs, increasing billing rates is outside their “comfort zone”

• Start incrementally and set a goal to increase billing rates over time – Increase rates for all new clients going forward

– Perform a review of all clients and the last time fees were increased

– For larger clients, undergo strategic account planning to identify client needs and demonstrate ability to increase “value added”

• More strategically, consider specializing in higher value services (like consulting) and speeding up the skill-building process in staff


32



Billing Rate Benchmarking


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Realization Defined

• Calculated as net fees billed divided by gross fees accrued – Incur $10,000 in “gross” time on a job and bill $8,500, our realization is 85%

• Realization is a measure of efficiency, indicating how well revenues are billed and collected compared to the gross time (and other costs) accrued on client engagements

– But high realization does not necessarily indicate higher overall profitability or net income for the firm

– Realization varies by service line and by firm size, with tax and consulting typically realizing higher than attest services

• Benchmarking surveys have a typical realization rates in the 80% - 90% range


34



Realization “Downers”

• The things that negatively affect realization include: – Inexperienced staff charging too much time compared to

budget and planned scope – the so-called “cost” of leverage • However, people must be developed and trained and if realization is

overemphasized, this will only serve to discourage your team!

– Overruns on fixed fee jobs without any upfront agreement with the client on a scope change

– People charging administrative time into jobs – which can help calculate the total cost of serving a client, but there must be a firm standard to get consistent realization measures

– Standard billing rates that are too high for your marketplace or client base

• However, it is better to be more aggressive rather than less aggressive on your standard billing rates as the more you aspire to charge clients, the more you are actually likely to collect

35



Realization “Inflators”

• The things that can falsely “inflate” realization include:

– “Hiding” or “eating” time actually incurred on a job and putting it to another charge or non-charge code

• This is “looking good” rather than doing good

– Billing charges you can’t collect and looking more realizable until the bad debt write off occurs

– Billing rates that are too low • If your firm is billing 100% of time incurred, your billings are too

low and this represents missed opportunity

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Improving Realization

• Based on benchmarking, firms with the highest NIPP tend to have higher leverage and lower realization, indicating that the most profitable firms give leverage priority and invest in a strong team and “pipeline” of future firm leaders

• There will always be “tension” between leverage and realization, but realization rates can be improved in the following ways:

– When delegating assignments, establish “clarity of commitment” with detailed descriptions of deliverables, by-when dates, time budgets and a return and report process, documented by written email recaps

– Teach everyone the importance of resetting expectations with clients and team members as soon as possible, to avoid and minimize budget / scope overruns

– Regularly perform an “A-B-C” client ranking exercise to raise fees or eliminate low realization client work


37



Realization Benchmarking


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Margin

• Calculated as net income divided by net revenue (for the firm as a whole or for an office, service line, or engagements)

– If net income of $1,000,000 and revenues are $3,000,000 your margin is 33%

– Again, it can be tricky to get an apples-to-apples comparison depending on what expenses are included in the calculation of net income

• The concept of margin comes “full circle” to importance of leverage and investing in training, mentoring and retaining people – the highest, most important “cost” in CPA firm business model

• A margin of 30% is considered to be good standard for most firms, however firms with higher NIPP are willing to accept lower margins rather than “scrimping” on people costs

– Seek margin improvement through higher billing rates rather than lower people costs!


39



Margin Benchmarking


40



Firms with highest NIPEP tend to emphasize higher leverage and

billing rates, with lower utilization, realization and margin

41



Bringing It All Together

• Here is an illustration for the IPA Best of the Best (“BOB”) and IPA average for $50-$75 million firms


(a) (b) (c) (d) (e)

“BOB” 9.4 x 1,488 hrs. x $212 / hr. x 86.5% x 39.2% = $1,003,506

$50-$75 10.4 x 1,296 hrs. x $230 / hr. x 83.4% x 27.9% = $ 721,167

“BOB” $30-$50

(f) Total charge hours: 13,987 (a) x (b) (f) Total charge hours: 13,478 (a) x (b)

(g) Gross revenue: $2,965,286 (f) x (c) (g) Gross revenue: $3,100,032 (f) x (c)

(h) Net revenue billed: $2,564,972 (g) x (d) (h) Net revenue billed: $2,585,427 (g) x (d)

(i) NIPP: $1,003,506 (h) x (e) (i) NIPP: $721,167 (h) x (e)

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Staff Profitability

• Many staff do not understand their own impact on profitability – And do not fully understand the magnitude of not putting forth the

required “effort” or the importance of keeping team members and clients informed – in advance - when budgets and schedules are not going to be met

• Here’s how many staff think about practice economics: – My hours x billing rate

– Less: my salary and bonus

– Equals partners are making lots of money!

• Be sure to give your staff the “full picture” including investments made in benefits, training, technology and firm overhead – don’t assume they understand these concepts already!

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Other Metrics – A/R and WIP

• Billing and collecting on a timely basis not only improves cash flow, but can improve realization and profitability by dealing with overruns and billing issues more immediately

• A/R and WIP – Calculated as either the number of months of A/R and WIP as of a certain

date or as percentage of net revenue

– The IPA 2016 survey shows average billed and unbilled receivables as a percentage of net revenue ranging from 19.7% to 26.8% depending on firm size, with the Best of the Best averaging 20.5% of net revenue

– Rosenberg’s 2016 survey had this as ranging from 2.2-2.9 months depending on firm size

• This equates to 18%-24% of net revenue

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Other Performance Measures

• Many don’t want to establish non-financial goals because they feel “soft” or difficult to measure

– But they can be measured using tools like a sales pipeline report, tracking the number of mentoring meetings and requesting forms be completed at each meeting and more

• Examples:

– Brought in X new audit clients worth $XX,XXX by XX/XX/XX

– Developed procedures and best practices associated with estate and gift tax service line that are approved by the Tax Department Head and trained all Tax staff by XX/XX/XX

– Completed the performance reviews by June 30, XXXX and all quarterly performance mentoring meetings for Bob Smith, Julie Webster and Scott Anderson turning in mentoring forms by the close of each Quarter

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Next Steps

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What Can You Do?

• Share any insights you gained with others in your firm

• Look into whether your firm is subscribing to one or more of the CPA firm surveys – Most supply the data geographically and by firm size so that you can

get a more reflective group to benchmark against

• Benchmark your firm’s performance against its peer group and explore changes that might move the needle closer to those of the top performers – Remember that numbers can sometimes mask significant deficiencies

in long-range investment in culture and future capacity

– It’s possible to look great now, but not be operating in a sustainable manner – look hard at the impact changes will have on your firm – especially to culture – before making them

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Poll #5

• What one thing will you do now that you’ve participated in this course?

– Study these materials in detail for greater understanding

– Share what I’ve learned with others in my firm

– Determine how my personal success is measured

– Find out what metrics are most important for my firm

– Other (enter in the question box)

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Thank You!

• Contact us at any time!

Jack G. Lee III, CPA (414) 659-9822

[email protected]

http://www.linkedin.com/in/jackleecpa

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Resources

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ConvergenceCoaching Resources

• ConvergenceCoaching’s web site includes information at:

– www.convergencecoaching.com

• Read our Coaching Concepts newsletter:

– http://www.convergencecoaching.com/coachingconcepts/

• Visit our blog for posts on these topics:

– www.convergencecoaching.com/blog

• Visit our learning center for access to additional courses and our Leadership and Communication, HR, Marketing and Sales Toolsets:

– http://www.convergencelearning.com

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ConvergenceCoaching Resources

• Visit us on Facebook: – http://www.facebook.com/convergencecoaching

• Visit us on LinkedIn: – https://www.linkedin.com/company/convergencecoaching-llc

• Visit us on Google+: – https://plus.google.com/+Convergencecoaching

• Visit us on Instagram: – https://www.instagram.com/convergencecoaching/

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Transformational Leadership Program

• The TLP Session One runs from June 1 to May 31 and Session Two runs from September 16 to September 15 each year

• Each Session’s class size is limited to 26 participants. Over the twelve-month period, participants experience:

– In-depth self-assessments

– Two in-person workshops

– Online, self-study and instructor-led web seminars

– Tailored one-on-one coaching sessions for them and their in-firm coach

– A difference making firm project of their choice

• The fee for your managers and newer partners to honestly identify their strengths and develop strategies and skills to drive performance improvements as they prepare to take on meaningful roles in leading and managing your firm is $6,500

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Benchmarking Resources

• Inside Public Accounting Annual Survey and Analysis of Firms

– www.insidepublicaccounting.com

• Rosenberg MAP Survey

– www.rosenbergassoc.com

• BDO Alliance Financial Benchmark Report

– https://alliance.bdo.com/

• AICPA PCPS/TSCPA National MAP Survey

– www.aicpa.org/pcps

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CPA Firm Metric Resources

• “Consulting Services Can Grow Your Firm – If Properly Managed” by Jennifer Wilson

– http://www.journalofaccountancy.com/newsletters/2016/mar/consulting-services-can-grow-firm.html

• The Firm Of The Future by Ronald J. Baker

• “The Firm Of The Future” article by Ronald J. Baker – http://www.journalofaccountancy.com/issues/2008/nov/the-firm-of-the-

future.html

• “Get Results: Improve Your Accounting Firm Processes Using Lean Six Sigma” by Dustin Hostetler

– http://www.journalofaccountancy.com/Issues/2010/Jan/20091484

• KnowAccounting.com – http://www.know-accounting.com/glossary/index.php

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• “Manage Time, Leverage Talent” by Edi Osborne – http://www.theprogressiveaccountant.com/running-a-firm/manage-time-

leverage-talent.html

• Managing the Professional Service Firm by David H. Maister

• “Managing the Professional Services Firm Book Review” – http://www.thefreelibrary.com/Managing+the+Professional+Service+Firm-

a015786976

• “Metrics of Greatness” by Gary S. Shamis and Jay N. Nisberg – http://www.journalofaccountancy.com/Issues/2006/Oct/MetricsOfGreatness

• “Selling Professional Services? It's All About Leverage” by Barbara Bix – http://www.marketingprofs.com/7/selling-professional-services-all-about-

leverage-bix-edwards.asp

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• Strategic Management of Professional Service Firms by Bente R. Lowendahl

• “Want to Make More Money? Focus on Revenue-Producing Behaviors” by Jennifer Wilson

– http://www.journalofaccountancy.com/newsletters/2016/apr/revenue-producing-behaviors.html

• “What Are Your Business Model Deal-Breakers? Six Non-Negotiables to Consider” by Jennifer Wilson

– http://www.convergencecoaching.com/what-are-your-business-model-deal-breakers-six-non-negotiables-to-consider/

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Documents

CPA Firm Success Metrics: Understanding Practice Economics · 2016. 11. 2. · the reasons and need for CPA firm success metrics •Then, we’ll gain a deeper understanding of the