Five Ways to Improve Operating Margin during COVID

Industrial metal number 5Are you too generous with your write-offs?

By Bill Penczak

The pandemic has placed a damper on new business activities for most CPA firms, with a paucity of events other than Zoom meetings and many clients hunkering down and not making any changes to anything least of which their accounting firm relationships, under some semblance of normal.

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The managing partners to whom I’ve spoken, various articles and social media posts suggest embracing your people and your current clients as the best coping strategy for now, which is a solid approach.

So when it comes to preserving your original 2020 profit goals – or at least salvaging them – firms have an opportunity to seek better processes or staffing options, or both to pivot to the times. As a CFO I once worked with used to say, “You can either raise the bridge or lower the water.”

Here are five options for lowering the water (labor cost) as a short- and long-term strategy for greater firm success:

  1. Tie partner compensation to margin contribution. The old metrics of the book of business or origination are too simplistic, and at the end of the day, the only thing that matters is the margin. Well-run tax departments can earn an excellent margin on $1,000 1040 returns when managed properly, as an example. Too many audit engagements deliver poor margin because of writeoffs (more on that later), poor workflow management, or crummy information from the client. Too few firms focus on profitability because it’s “too hard to calculate” as one firm partner told me, which I found ironic for a field known for its financial prowess. But if partner bonuses were more closely tied to margin instead of revenue, behaviors, and profitability would likely change.
  1. Offshore resources. Middle market firms have long pushed back on the idea of using offshore resources to perform staff and senior staff engagement functions. Forgive the pun, but the notion is foreign to most, because of cultural differences, language challenges, and time zone spectrums. But the Big Four firms have used offshore resources for at least a decade, if not longer. Consider this staff resources with the equivalent of a CPA degree in the Philippines can cost about $8 per hour. Your staff person at $55,000 salary, plus a 20 percent overhead allocation, cost approximately $36 per hour. The challenge for firms is determining how to start the process, from where to source the offshore resources (Philippines, Central Europe, India, etc.), and maintaining the security of client data. These are challenges other firms have mastered, and are not insurmountable.
  1. Remote staff from “flyover states.” For firms reticent to offshore, “nearshoring” is another viable option, where language and time differences are fewer (although it could be a funny exchange between someone in NYC and the deep South). There’s a nearly 20 percent difference for the cost of a staff person in states such as Michigan, Mississippi, and Iowa ($47,700 to $49,800 per year, according to and Massachusetts or New York ($59,800 to $60,400 per year). The success factors would be defining scope, having specific process mapping, and regular communications. Not insurmountable, especially considering most firms have operated remotely since March.
  1. Down Under. Consider this about Australia they speak King’s English, with a cool lilt. They are, in my experience, really easy to work with and most importantly, their reporting deadlines, like their seasons, are the opposite of those in the U.S. It wouldn’t require rocket science to combine audit teams in the U.S. and Australia who could share work year-round to meet June 30 and December 31 year-end deadlines. Firms could reduce staff, increase utilization, and maybe get a few trips to the Great Barrier Reef in the process.
  1. Value pricing. The notion of value pricing is a difficult one for many firms, as the topic has been discussed for years and few firms have adopted it. The concept is that rather than billing by the hour, clients would be billed for the project deliverables, with very specific parameters and timelines. One firm of which I know that has successfully adopted value pricing conducted a small-scale test in the first year, tweaked the structure, and rolled it out on a larger scale the following year. The key, I’m told, is tightly defined scope, upcharges when clients don’t hold up their end of the bargain (often not having their records ready on time) and the courage to charge the client when they don’t abide by the previously set parameters. This can involve tough conversations and flies in the face of the 100-year-old tradition of CPA firms to bill by the hour. But difficult times like these present opportunities to rethink old conventions.
  1. Writeoffs. I saved the best for last. One managing partner of a firm with which I worked a few years ago told me that they were writing off 10 percent of their gross billing. Upon investigation, many of the partners were avoiding the inevitable by not billing all their WIP, and keeping it in a semi-permanent financial purgatory until which time management let the partners write it off. The underlying problems are threefold: poor scoping, time dumping, and bad communications internally and with the client. I will do a deeper dive later on write-offs in another column because I believe that minimizing write-offs is the lowest hanging fruit when it comes to firm profitability. Two resources if you’re interested in this topic:

I wrote a few weeks ago about how some firms and managing partners have become more introspective about their firm and the industry in the time of COVID. While such navel-gazing may be out of the comfort zone for some, increasing the profitability of your firm in tough times by considering alternative staffing models should be in the comfort zone of any firm. It just might take a bit of prodding to get there.