To help practitioners meet the challenges, and seize the opportunities, in an uncertain economy, the AICPA Specialized Publications group has worked with the AICPA’s Private Company Practice Section (PCPS) to develop the Practice Forward series. Books in this series will offer practical, hands-on advice on new and emerging topics of concern for CPA firms, as well as updated approaches to perennial issues. In the current release, Ride the Bear: Strategies for CPA Firms to Survive, Thrive, and Grow in a Down Economy , author Michael Ramos tackles the daunting issue of how CPA firms can position themselves appropriately to take advantage of the kinds of opportunities the current economy presents. The synopsis presented here features many of the key points made in this publication. Turn to the complete publication for more tools and discussions that CPAs can use to implement the insights discussed here.
Over the past few months, CPA firms have seen their clients report losses and weaker balance sheets. They have watched clients struggle through liquidity issues, employee layoffs, and severe cost cutting measures. Some of their clients have declared bankruptcy. Others are seriously at risk of it, for the first time ever.
Economic historian Niall Ferguson describes the current economic crisis as “a fundamental breakdown of the entire financial system, extending from the monetary and banking system through the bond market, the stock market, the insurance market and the real-estate markets.” Your clients may not be directly involved in any one of the industries most affected by the crisis, but because of the structure of the modern financial system, a seemingly isolated breakdown can ripple throughout the entire system and affect businesses far removed from Wall Street. Since the beginning of the recession, the economy has shed millions of jobs, leaving a wide swath of unemployment in its wake.
There is no question that CPA firms have suffered alongside their clients. Firms have lost clients that have declared bankruptcy. Audit practices have been hurt by clients who convinced their lenders that an annual audit was no longer necessary. Firms have lost consulting engagements and special projects that fell victim to their clients’ cost-cutting measures. Not surprisingly, CPA firms have reacted by reexamining their own practices, laying off staff, and cutting nonessential expenses.
One of the hallmarks of successful CPA firms is an ability to respond effectively to client needs. As your clients make changes in response to the current economic environment, those changes may define a whole new set of needs. Changes in your clients’ needs will create new business development opportunities that imaginative and quickly moving firms will be able to exploit. One of the keys to taking advantage of these opportunities will be the ability to anticipate and analyze how your clients are responding to the current economic downturn.
While the recession and the related changes in public policy have dominated the headlines recently, you should not lose sight of broad trends that began well before the recession and that will last after the recovery is well under way. Two trends bear mention because of their potential to significantly affect the profession:
Globalization. Globalization is becoming increasingly important in the profession through the convergence of U.S. generally accepted accounting principles and International Financial Reporting Standards and the convergence of U.S. auditing standards and their international equivalents.
Communication patterns and technology. For example, social networking and the trend toward online collaborative work environments already are changing how CPA firms do business. Extensible business reporting language (XBRL) will change how companies prepare and file their financial reports.
Your Firm’s Response
As the realities of the recession begin to sink in and the government’s responses begin to have an effect, your firm will need to develop its own response. Some firms believe that because the recession has had little-to-no impact on their clients or them, there is no need to make any changes. In the short term, standing pat may be sufficient, but in the long term, firms that make no changes to their pre-2007 business model run the risk of being overtaken by their competitors. During a recession, the biggest risk to a firm is choosing to stand pat.
Firms that choose to stay the course not only miss the chance to cash in on new opportunities, they also risk becoming anachronistic. If your clients are aggressively fighting to stay viable in these difficult economic times but see their most valuable financial advisor acting as if nothing has changed, won’t they begin to wonder if their CPA advisor “gets it?”
The steps outlined below will help you strike a balance between rash, aggressive action and standing still, so that your firm is stronger coming out of the recession than it was going in.
Priority 1: Get Your Financial House in Order
Bill and Collect
As a general rule, accounting firms have extremely high receivables and work in process balances. In a recession, however, cash is king. Your first move should be to collect your current outstanding receivables. Or better yet, use your experience in collecting receivables now to institute lasting changes in your billing and collection procedures.
Adjusting Your Client Mix
Not all clients are created equal. The AICPA Private Companies Practice Section (PCPS) notes that 20 percent of your firm’s clients account for 80 percent of your firm’s profits. PCPS recommends that you regularly evaluate your clients, and use this evaluation as a starting point for your client retention plan. Focus on the best clients, terminate relationships with the worst ones, and work to improve the relationships with all those in the middle. The current recession provides a perfect rationale for explaining to those clients you terminate why your firm can no longer provide services to them.
Turn Up Your Key Performance Indicators
The main profit drivers in a professional services firm are the following:
Leverage. The ratio of staff to partners.
Utilization. The ratio of billable staff hours to total available staff hours.
Billing rates. The amount charged for services offered (not applicable for value-billing
engagements).
Every two years, the AICPA PCPS publishes its National Management of an Accounting Practice (MAP) Survey, which tracks these and other performance measures for thousands of CPA firms. These statistics are organized according to firm size and geographic location, which makes it easy for you to benchmark your firm against your peers. Make those comparisons and carefully evaluate the differences between your firm and your peers. Small changes in just one of the key profit drivers can have a profound effect on partner profitability.
Position Your Firm for the Subsequent Recovery
The most common overreaction for firms entering a recession is to cut back more than is needed or to cut in the wrong places. Firms that make across the board cuts to all discretionary budget items end up having to spend more to get up to speed when the economy rebounds. For example, time and out-of-pocket costs of laying off and then rehiring to get back up to capacity are significant. Firms will need to balance their short-term and long-term goals.
Align Costs and Service Offerings
Over the years, your firm has established a “pattern of decisions” that “determines and reveals the goals of the firm.” For example, your firm may have decided to perform only financial statement reviews, compilations, and write-up work but no audits. Or it may have ceased doing work of any kind for state and local governments. Or, perhaps, it has invested heavily in building up a forensic accounting practice. Whether you realize it or not, your firm has defined its service offerings.
What about cost structure? Is it aligned with your service offerings? Are decisions relating to personnel, compensation structure, or IT investments consistent with and supportive of the services you offer your clients?
Decisions about the actions you will take in response to the current economic downturn should be evaluated within the overall context of alignment. Given a variety of choices, ask yourself “which one will help us better align our service offerings and cost structure?” Answering this question will help you make more effective decisions about how your firm will respond to the current economic conditions.
Analyze Your Firm’s Service Offerings
Many firms manage their practices according to subject matter expertise; for example, tax, audit and accounting, and consulting. Other firms are organized around individual partners’ books of business; that is, partner A serves all the needs of one group of clients, partner B the needs of a separate group, and so on. For strategic planning purposes it is helpful to look at your firm’s service offerings from a different perspective by focusing on the characteristics of those services that drive your value proposition. On any given engagement, think of your services as primarily delivering one of the following three values:
1. Compliance with regulatory or other requirements. Examples: tax return preparation, financial statement assurance services, write-ups, and bookkeeping.
2. Problem-solving through the innovative and creative application of expertise to solve the client’s most difficult problems. Example: Sarbanes-Oxley Act of 2002 Section 404 consulting (circa 2003).
3. Solutions based on applying learning from experience to specific circumstances. Examples: implementation of IT software, tax planning, more complex tax return preparation, and financial statement assurance services.
Compliance Oriented Service Offerings
Most CPA firms offer services that are geared primarily toward having their clients comply with regulatory requirements, debt covenants, partnership agreements, or some other obligations to report financial information. These engagements vary in terms of complexity, and you may have to utilize a great deal of expertise to complete these engagements. But in your client’s point of view, their perception of the value of the service is what counts. It is not uncommon for clients to see compliance-oriented services as commodities, no matter how hard you try to convince them otherwise. For that reason, billing rates for these types of services usually are lower than for other types of services.
Problem Solving Engagements
Problem-solving engagements are the exact opposite of compliance-oriented services. There are no checklists or work programs or other road maps. All you have is your expertise, creativity, and resourcefulness and a client with a complex problem they may or may not be able to describe. Indeed, the first step in this type of engagement is to describe for the client the process you will follow to define the problem and explore various solutions. Your initial deliverable is an implementation plan. Executing the plan is an entirely different phase of the project
Solution Based Engagements
Solution-based engagements are halfway between a compliance-oriented engagement and a problem solving engagement. You may think of them as the following:
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More complex than a common, standard compliance-oriented engagement; and
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More structured than a pure solution-based engagement.
When you begin to categorize engagements this way, it is easier to analyze important considerations, such as the selling position for each service area, the required organizational infrastructure and project team to perform the different types of engagement and the challenges for each one. Using this information, you can then make broader strategic decisions about the most profitable and effective mix of engagements for your firm.
Deciding Where to Invest and Where to Cut Staffing and Compensation
Compensation is the single biggest expense in a professional services firm. In general, compensation expenses at a CPA firm are 30 percent to 35 percent of gross billings, so it is natural for firms to look for ways to cut compensation expenses. However, it’s important to make strategic cuts that consider ongoing service demand, future opportunities, outplacement costs and creative alternatives to layoffs.
Other Expenses
Other expenses such as occupancy costs, marketing, and IT typically comprise another 30 percent to 35 percent of gross billings. Your decisions about these costs will depend on where you want to position your firm on the service offering spectrum. You should consider not only your position today, but also where you want to be positioned when the recovery begins. Be sure to keep in mind many external factors that will affect your position.
What It All Means for CPAs
In response to a once-in-a generation recession, the federal government is taking bold, once-in-a-generation action, and they are redirecting huge sums of money to middle class tax relief, education, energy, and healthcare. Follow the money–it leads to new business.
As we saw with the Sarbanes-Oxley Act, public policy changes can create business development opportunities for CPA firms. The current recession is deep, and the changes coming from Washington are staggering in their scope. The stimulus bill, the budget, and other changes that may soon be coming will fundamentally restructure the U.S. economy. And while all of that is going on, the playing field (and the rules of the game) will become increasingly global and technology will completely transform the way we do things, possibly several times over. The firms that will grow in this new environment are the ones that take the calculated risk of getting out of their comfort zone and–in the cases where it makes sense–putting their resources in play to grow new lines of business.