Background On Our Industry – CPA Practice
CPA practices provide accounting, tax preparation, and auditing services to businesses, non-profit organizations, and individuals. Tax preparation and tax planning work for organizations and individuals comprise about one-third of overall CPA client fees but are typically over half of client fees for smaller firms. Tax work is about evenly split between individuals and organizations. Financial auditing is the next largest category of work and is also about one-third of overall CPA firm client fees. Most CPA firms perform financial audits only for private businesses and nonprofit organizations. Only the very largest CPA firms offer audits of publicly-held companies. Other services provided by CPA firms include bookkeeping, general accounting services, business valuations, management consulting, and information technology consulting and implementation.
A typical CPA practice will have less than ten employees
. New CPAs start out as Associates and earn an average salary of about $42,000. Salaries for Senior Associates (4-5 years experience) are typically $63,000 to $96,000, while Managers (6-10 years experience) earn $73,000 to $128,000 and Directors earn $92,000 to $225,000. Achieving status as a Partner, or owner, in the firm, is the goal for CPAs. Salaries for Partners range from $184,000 to $309,000, but they also share in the profits of the firm. Firms may build up cash before periodic distributions of profits to partners. Other employees at CPA firms include administrative and clerical staff. Firms spend about 26-28% of revenue on salaries for all employees.
Partners and Directors have primary responsibility for acquiring new clients and managing relationships with existing clients. Associates and Senior Associates perform data gathering, analysis, and reporting for client engagements under the direction of Managers or Directors. On average, CPA firms invest about 1% of net revenue on marketing activities. CPA firms are typically managed as a unified practice with partners sharing resources, clients, staff, and profits. In some firms, each partner leads their practice, and the only sharing is of administrative systems and resources. This “silo” approach works for smaller practices but creates management challenges if the firm grows beyond about ten partners. Demand for CPA services is seasonal, with higher demand during “tax season” (February through April). CPAs often work overtime during tax season to meet this higher demand. Some employees may only work part-time during non-tax seasons when demand is lower.
CPA practices measure profitability by “Net Remaining per Owner” – the amount that partners can take out of the firm. Across all firms, net remaining per owner averaged about $248,000 in 2016, but it ranges from approximately $48,000 for small firms to about $482,000 for the largest, according to the latest survey by the AICPA
High Utilization Rates
Since CPA firms sell the time and expertise of their professional staff, their profitability is driven by the utilization rate of the staff’s time and the billing rate they realize for that time. Utilization rates, the percentage of staff time that is billable, average 70% for CPA firms. Non-billable time includes vacations, continuing education hours, and staff meetings.
High Realization Rates
Firms may discount billing rates to win business or address client satisfaction issues. The “realization rate,” the ratio of actual to standard billing rates, averages about 86% for CPA firms and declines as the firm gets larger. Billing Rate Mix Billing rates vary depending on the experience of the CPA. Billing rates average $8579-101 per hour for Associates with 1-3 years experience and $125-312 per hour for Partner/Owners. Billing rates also vary depending upon the work being performed and the expertise of the CPA. Routine work, such as bookkeeping and general accounting, earn lower rates than higher value-added work, such as consulting and planning. CPAs with in-depth experience in specific areas, such as business valuations, or specific markets, such as medical practices, can command higher rates for their expertise.
KEY CPA PRACTICE METRICS:
Net Remaining Per Owner: $248,000
Net Client Fees/FTE Professional: $182,000
Utilization Rate: 70%
Realization Rate: 86%
Developing expertise in specific vertical markets or services.
Training all staff members that marketing is part of their job and making them aware of the firm’s services and types of clients.
Expanding value-added consulting services as a “trusted advisor” to clients.
Investing in continuing education to keep staff up-to-speed on changes in regulations.
Using information technology to increase staff productivity and client collaboration.
Taking advantage of “cloud computing” to save money and eliminate management of servers.
Using part-time staff to manage seasonal demand.
(WIP) with more frequent billing.
Accepting credit cards from individuals and small businesses to reduce collection issues
Sell and Invoice
New engagements are sold by partners or designated “rainmakers” within the practice. Firms rely heavily on existing clients for referrals and banks for new business. Likewise, CPA practices are an excellent source of referrals for bankers. On average, firms only spend about 1% of net client fees (revenue) on marketing activities. For auditing or accounting work, firms typically prepare a formal proposal to bid on the project.
CPA firms often have high work-in-process (WIP) – hours worked for a client that is not yet invoiced. Small jobs, such as tax returns, are billed upon completion. Progress payments may be invoiced for larger jobs. These are tied to specific milestones or percentages of the total estimated hours for the job. An upfront retainer fee may be requested for certain jobs or clients, particularly if the firm has to hire or contract out for special expertise.
CPA firms have very little bad debt, but may be forced to lower their billing rates to facilitate client payment. Collection periods average 13 to 28 days, though a significant amount of receivables can extend over 90 days. When write-offs occur, they are often caused by clients going out of business.
CPA practices face the seasonal demand for tax services, which accounts for about a third of revenues and peaks in February, March, and April. They build cash reserves during this time. Firms may rely on lines of credit to meet expenses during “slow months,” such as January and the summer months.
The main expenses for CPA practices are payroll and occupancy costs. Salaries for employees average 26-28% of revenue. Rent is typically about 4-5% of revenue. Other expenses include computer and phone systems, reference materials on tax laws and accounting standards, and insurance.
CPA firms typically monitor hours and fees charged to clients on a weekly, or even daily, basis. Practice management systems collect staff hours worked by client project and use standard billing rates to calculate fees. Besides client fees versus plan, firms also track the utilization rates of employees, realization rate, client retention rate, work in progress, accounts receivable, and the staff-to-partner ratio.
Risks to Watch Out
For Business Failure and Merger Rate
CPA Practices Fail or Merge Less Frequently
The business failure and merger rate for CPA practices from the end of 2015 to the end of 2016 was 8.41%, lower than the average for all U.S. businesses, according to data from Bizminer. “Business failures and mergers” include those firms that ceased operations during the period, as well as firms that ceased being independent entities due to merger or acquisition.
As the economy improves, CPA firms are focusing on attracting new clients, but client retention remains a concern for many practices. Clients experiencing financial difficulties may cut back on discretionary projects, shop around for lower fees, or go out of business. Even though retaining an existing client usually costs less than acquiring a new client, many CPA firms have difficulty not billing for time spent with existing clients, since performance measures are often tied to utilization rates. As a result, they may under-invest in providing services that could help clients recover, and that could strengthen their long-term relationship with clients.
Competition for Talent
Demand for hiring accountants and auditors is expected to grow 16% between 2010 and 2020. Hiring will be driven by growth in the number of businesses, changing regulations, greater financial scrutiny of companies, and a surge in retiring CPAs. Firms are looking for graduates with advanced degrees at a time when schools are struggling with tight budgets and constraints on their capacity to teach large classes. The result may be a limited pool of talent with advanced degrees, which could push wages up for new accountants.
Changing Tax Laws and Accounting Standards
Keeping up with changes in complex tax laws and accounting rules is a major challenge for CPA practices, particularly smaller ones. New regulations to increase financial reporting transparency are affecting CPA practices, and the adoption of IFRS will drive further changes. Difficulty in keeping up with change can cause firms to specialize in particular industries or services to limit the breadth of knowledge they must maintain.
Competition from Large Firms
Local CPA practices compete for clients with the “Big 4” national accounting firms, as well as large regional firms. Large firms sell the wide range of expertise available in-house across all their offices but have more overhead and higher billing rates than local practices. However, the Big 4 are opening offices in India, giving them access to low-cost labor for outsourcing and tax preparation services.
Difficult economic times can cause business owners to blame their advisors for financial difficulties. CPA practices may face lawsuits from small business owners over tax liabilities and investors in public companies over audit opinions. CPA practices carry liability insurance to reduce their financial exposure, but lawsuits still take time and attention away from revenue-generating activities.
Technology a Top Concern
Technology and related issues are top concerns in the accounting industry and pushing firms to stay ahead of the curve. An informal survey of the top executives cited a wide range of implications for accountants, from dangers posed by automation and hackers to new services through data analytics, according to Accounting Today. Disruptive technologies like data automation, Blockchain and artificial intelligence are expected to change the nature of the services accountants offer. Automation technologies are a positve disruption but require accountants to rethink their processes and the way they deploy technologies within their firms. Blockchain and artificial intelligence, though not ubiquitous at this point, have the potential to displace thousands of jobs within the accounting profession, especially for cyclical services like bookkeeping, audit and tax preparation.
CPA Practices Hiring
The market outlook for accountants remains strong, and firms are looking to grow their workforces. During the 2Q 2017, industry employment is projected to grow 1.8%, according to the AICPA’s Business & Industry Economic Outlook Survey, the same level as the 1Q 2017 and the highest since a 2.1% growth forecast in the 4Q of 2015. The plan-to-hire percentage has risen five consecutive quarters and increased from 15% to almost 25% between the 1Q and 2Q of 2016. With wage and employee costs rising
Ethics Fall Short
CPAs that work in industry and government rate their ethical environment as inferior to public accounting firms, according to a study in Behavioral Research in Accounting, published by the American Accounting Association. CPAs in government and industry gave their environment scores of 64 and 67 (on a 100-point scale), compared to CPAs in public accounting and Big Four firms, which gave their environment a score of 73 and 76, respectively. The higher ethics scores among the Big Four came as a surprise, given recent well-publicized problems. Low scores among government CPAs was especially concerning and reflected a diminished trust in government seen in other public surveys.
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