In the first of a five-part series on the priorities for CPA firm management, Ira Rosenbloom of Optimum Strategies in Spring House, Pa., joins us to discuss the top five metric categories to keep an eye on to ensure success. Among the factors he covers are achieved rate per hour, gross profit margin, and pipeline management and turnover.
By: Bill Hayes, Pennsylvania CPA Journal Managing Editor
Today, we'll be kicking off our monthly series that we'll be doing with friend of the podcast, Ira Rosenbloom of Optimum Strategies in Spring House. It's going to focus on the top management priorities for CPA firms and today we are going to be concentrating on metric categories that need to be monitored in the future, both immediate and down the line.
Before we get into the first question, I figured we would just reveal our top five for the day and then we'll jump into them. Today, we'll be talking about achieved rate per hour, accounts receivable turns, gross profit margin, pipeline management and turnover, and then potential. Let's start with potential now that we've given people an idea of what we're going to talk about. What exactly does potential entail?
[Rosenbloom] Potential has a wide perspective to it. In the more traditional sense, what I would capture under potential is if we have 10 people working on clients and they will be working so many hours a year at so many dollars per hour, that means our potential is that formula. If, for example, those 10 people could generate $2 million worth of business and yet we're running at a run rate of $1.4 million, we have $600,000 worth of untapped potential.
Managing the potential is crucial from the standpoint, number one, you want to get the proper mileage on the people that are working with you. Number two, it's always tempting to say we need more people to do the work. But if our potential is there, it will allow us to focus. Do we have the right people given the kind of work that we have, which is the other element of potential. What is the nature of new work that's coming in? And do we have the players in house to meet that potential?
Focusing on that metric in dollars and cents and hours and in dollars and cents of the inflow is crucial toward a strong management platform. Today we live in a world where resources are hard to come by. People are becoming ultra creative about how they find the producers.
That's another element of potential where we may not just be looking at the people who are conventionally here, but firms are offshoring and firms are turning to outside providers, which expands and explodes your potential. We don't want to disappoint. We don't want to not deliver to the client. We also don't want to disappoint our partners and not have the proper bottom line. Potential is huge.
Next on the list is pipeline management and turnover. What are we looking for there?
[Rosenbloom] What we're looking for there is to have an orchestrated process where new business follows in a methodical process. We are again able to tie utilization of resources toward the demands that we expect to have to manage. If we're going to pursue new business and new business is going to come our way, what is the lag time or the lead time between having the conversation with that potential client or the source of the new project and then following up and closing or writing it off?
We need to establish a timeline for that to be workable for us, recognizing that at times of the year that timeline is going to be different and our ability to live up to that timeline will vary. There are those firms who can be ultra responsive during tax season because they're primed and programmed to be around and then after tax season they're much more laid back and there are other firms who can't get to it during tax season because they're so focused on the existing client base and they will be more responsive after tax season.
But new business is not like a good wine. It doesn't get better over time. You have to be attentive and you have to be on top of the opportunity so that it doesn't end up in somebody else's bucket.
In the area of gross profit margin, what are we looking to monitor there?
[Rosenbloom] In an accounting firm, we're very much a function of the cost of our labor. We sell time. Ideally we'd like to sell a lot more products than time, but we pay people for their time and for their productivity. We want to be sure that our margins are healthy margins given the fact that labor is increasing in cost at a significant clip because it's hard to come by.
When we look at our gross profit, it's also tempting not to allow for a cost factor for our ownership group. We want to be sure to add something for that ownership group, not to take into consideration the ultimate distribution of profit that's going to come, but there is a cost factor for having a partner perform their functions.
At the same token, there's a cost factor for having administrative components, so we want to look at our receipts minus all of those labor costs that are relevant to client service, which includes having a very talented administrative core, very meaningful. The greatest contribution to our bottom line is our gross profit margin. But we've got to look at the payroll, the benefits, the training costs so that we have the proper line items that go into our cost of labor to define our gross profit.
What exactly is meant by accounts receivable turns and why are they so important?
[Rosenbloom] At the end of the day, this business of accounting, much like any other business, pays their bills based upon the cash they have available. If we are billing and we're not collecting with frequency, we're going to have cash difficulties and it's going to influence the behavior pattern of people because our staff wants to be properly rewarded.
We're going to want to have a bonus program to reward them for great work. Well, they did the great work, we send out the bill. Well, we don't bother to collect those dollars. Well, it's hard for us to turn around and then give them the proper type of bonus. We can't live our lives on the accrual basis. The accrual basis is a great reflection of the true income of the company, but at the end of the day, bills are paid on the cash basis and the same thing holds true with our compensation.
We need to motivate and create a system where we're very attentive to the turnover, how frequently we're collecting our dollars.
Given the fact that we visit clients less frequently. Years ago, people would visit a client monthly and quarterly and bring back a check. We don't do that as frequently. We're much more into the virtual technological advantages. We now have to go out of our way to find the ways to collect those dollars.
What's the importance of achieved rate per hour and how do you get it higher?
[Rosenbloom] The achieved rate per hour is relevant because that is going to be the major driver toward the gross profit margin and each firm, in its geographic area, will be effected by competitive forces. There are certain markets where you can only get X dollars for that particular service or that particular type of production. But our ability to create profit from that is important. That is the true reflection of our gross profit dollars.
Most accounting firms have a significant dialogue in and around realization, which is how much of their standard rate are they seeing, which is an important component. But if my rate is artificially low for the market and I'm getting standard, the fact that I'm at 100% realization, I'm depriving the firm of what we should have in our potential, which is a much higher rate per hour producing much better gross profit margins.
You get there by focusing on efficiencies, in terms of raising the achieved rate per hour, having greater efficiencies and focusing on the value of the service, not necessarily the time that went into it. So that we would look at how much we were able to bill out on somebody's time divide that by the time that went into it, but the fact that you could do a return in an hour because you've got 10 years worth of experience and your hourly rate is $400 doesn't mean that that return really isn't an $800 or $1,000 return. Therefore, that achieved hourly rate is now escalated. It's a combination of efficiencies, knowledge, and packaging.