Few accounting firms take proper account of the profitability of their various service lines. It’s time to take stock, says Derek Smith
This article was first published in the July 2018 International edition of Accounting and Business magazine.
For many accounting firms, the source of their profits is less clear than some of their clients might imagine. Although all firms hopefully know their bottom line, perhaps surprisingly not all know what drives their profits and which services or clients are the real profit-producers.
Many firms don’t know the real costs of winning, undertaking and retaining clients and assignments. Often, the high-profile one-off assignment with a fee of £50,000 – but an attainment cost of £10,000 – is heralded more loudly than the 10-year retention of a client with a recurring and escalating fee of £10,000, which was won with little or no cost and is paid by regular direct debit. It is not uncommon for firms to fail to recognise the lifetime value of clients or even record this invaluable historic information.
Accountancy firms are different from other professional services firms – in particular, when it comes to their relationships with clients. Lawyers tend to have more transaction-based than relationship-based dealings with clients, and often their service provision is more discrete or one-off than that of the accountant. By contrast, it would be unusual for an accountant to deal with a client’s accounts and not deal with their tax, for example. This has implications not only for structure but also for the nature of financial arrangements with clients, who, in many cases, may still be billed on a single-fee note for a multitude of different services.
Traditionally, partners would do everything relating to a client – be it accounting, auditing, taxation or general financial advice – but our world has changed and increased complexity means this is no longer appropriate. Organisation along service lines (audit, tax, accountancy, company secretarial, corporate finance, insolvency, financial services, etc) has become more commonplace. Even these structures, however, should probably be challenged, as they fail to recognise that some businesses increasingly want – and need – specialist advice appropriate to their sector.
There are still a large number of firms that make no attempt to analyse their profits with reference to the nature of the work that is being undertaken, or that make judgments based solely upon recoveries against charge-out rates. Even when firms attempt to assess profitability based upon charge-out rates, they often take no account of the cost of delays in payment or delays by partners in billing for work.
Some firms still seem to hold to the view that all types of work should make the same percentage contribution to profits. This is akin to supermarkets abandoning loss leaders but still believing they will attract the same level of customer footfall.
A key management goal should be to ensure that the source and nature of the profits are understood and that these are maximised. Without question, there are richer rewards in high-value, non-compliance work, but to seek to undertake such work without the bedrock of compliance work can be perilous, as shown by the demise of a number of established firms over the last 20 to 30 years.
Similarly, firms need to be careful not to link partner rewards too tightly to service-line profitability if they are to avoid the inevitable peaks and troughs that follow general economic trends – corporate finance and insolvency, for example, can be highly cyclical.
Horses for courses
Another problem is failing to structure work and analyse data appropriately. Firms need to take an overall view on performance and profitability, and partners must avoid becoming involved in work that should be handled by others in terms of cost or competency, or both. Many partners retain work that is either above or below their level of competence. The effect is not only a reduction in potential profitability but also a significant increase in risk.
Probably the most dangerous senior professionals are those who take on client work for which they are not adequately trained. This can also extend to practice tasks where partners undertake responsibilities for which they are ill equipped. Time and again, we encounter practices where the partners responsible for such areas as appraisals, recruitment or IT have little or no formal training in the area.
Allied to this is the area of non-chargeable activity. Clearly, working ‘on the business’ is as vital as working ‘in the business’; but it is equally important to ensure that such activities are planned, targeted, channelled and measured. In many cases, time that should be recorded as chargeable is recorded as non-chargeable and, as a result, any management decisions based on assessments of profitability are flawed.
There is also an increasing trend for firms to dispose of some parts of their business that they believe to be less profitable than others. While this can work, firms need to recognise that the more services they provide to their clients, the more likely they are to be viewed as a trusted adviser rather than a low-cost provider. They need also to consider a potential acquirer down the track, which might be reluctant to invest in a business where it is constrained by covenant from offering many of the services that it provides.
In the recent past, many firms have divested their financial services business lines, often because it is a struggle to find the right people to provide the service. What a firm needs to do is reflect on the nature of the service line and the skills of their employees. That said, though, don’t assume staff with a tax background, say, will be able to work with clients across other assignments. The added value that accountants can bring is to simplify seemingly complex issues and sell clients the solutions they need rather than what they think they want – and then use the right people to meet those needs.
Although Peter Drucker – the father of modern management thinking – said the ‘concept of profit maximisation is, in fact, meaningless’, he never suggested that profits should not be measured!
Derek Smith is a senior consultant at Foulger Underwood Associates
"Some firms hold the view that all work should make the same contribution. This is akin to supermarkets abandoning loss leaders"