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Practice Management

Industry survey shows more profitable accounting firms are bigger, charge more, do less audit work

David Wilkins  Content Manager for Tax & Accounting at Thomson Reuters 

David Wilkins  Content Manager for Tax & Accounting at Thomson Reuters 

A new survey of the accounting industry shows that revenue has fallen, but those firms that thrive are bigger and more selective about the work they do

Average accounting firm revenue increased just 5.7% in 2020, the slowest growth in eight years, according to the new edition of the Rosenberg Survey, an annual study of the CPA industry in the U.S.

The survey — released in September by consulting firm The Growth Partnership — aggregates and analyzes the financial performance of 315 accounting firms. For its analysis of year-over-year revenue, the report looks at firms with net fees exceeding $2 million annually, which represents about 90% of the firms that participated in the survey.

The last time the survey found revenue growth to be in the 5% range was 2012. From there, it climbed to 6.7% for two years, hovered between 7.0% and 8.1% between 2015 and 2018, then dipped to 6.4% in 2019 before falling to 5.7% last year.

The survey also showed that only three-fourths of accounting firms’ growth in 2020 was derived organically from operations. The rest was attributed to business acquisitions during a period of continued consolidation within the tax & accounting industry. “We are seeing M&A activity in small firms, medium-size firms, and large firms,” the report notes. “Firms, including Top 100 firms, are merging up to help with succession issues and lack of leadership, and/or to join forces with a larger firm who has the capital to help them make the transition from compliance to advisory” services.

Profitability

Average CPA firm profitability, measured by income per partner (IPP), was $521,000 in 2020, up 4.8% over 2019. (IPP grew about 6% the two previous years.) “We have been tracking a very interesting trend over the past 12 years,” the report states. “Prior to 2006, revenue growth rates fell short of IPP growth. But every year since 2007, the reverse has happened — revenue growth has exceeded IPP increases.”

The survey also offered several interesting takeaways, including:

The impact of firm size

The Rosenberg Survey has tracked the correlation between firm size and profit for more than two decades and found that “while being a larger firm does not guarantee larger profits, our data shows that the larger the firm, the more profitable it will be.” Here’s the average IPP by firm size in 2020:

      • Firms with more than $20 million in revenue generated $688,000 in IPP;
      • $10 million to $20 million — $519,000;
      • $5 million to $10 million — $504,000;
      • $2 million to $5 million — $343,000; and
      • Less than $2 million — $258,000.

Based on The Growth Partnership’s consulting work with accounting firms, the report attributes larger firms’ profitability to their ability to:

      • provide more advisory services;
      • attract larger clients;
      • engage in strategic planning, marketing, and practice development;
      • attract, retain, train, and develop staff and groom future leaders;
      • adhere to a strong set of core values and maintain partner accountability; and
      • establish a strong technology infrastructure.

“As more firms merge up, the small and mid-sized firms will have to compete against larger firms who are becoming stronger and stronger in these areas,” the report adds.

Aggressive billing rates

Another factor impacting profitability is the ability to collect higher billing rates. “When consulting with firms, we consistently see firms with aggressive billing rates outperform those with lower rates,” says Charles Hylan, a managing director at The Growth Partnership and lead author of the Rosenberg Survey.

The survey finds this is true regardless of the size of the market in which accounting firms operate. For example, in markets with populations greater than 2 million, firms with the highest partner billing rates generate $744,000 in IPP, while firms with the lowest rates generate $369,000 in IPP. The pattern holds in markets with a population of less than 250,000, where firms in the top-quartile for billing rates earn $516,000 in IPP, while those in the bottom quartile earn $280,000 in IPP.

survey
Charles Hylan, of The Growth Partnership

The report suggests that the factors behind this trend are behavioral, attitudinal, and operational. Simply put, those firms with higher rates compete more aggressively, believe they are worth every penny they charge, and provide more advisory services and less compliance services.

Rate realization

The report notes that some CPAs believe firms with high billing rates discount their work more heavily than firms with lower rates, but the survey finds this to be untrue year after year.

In 2020, for example, firms with the highest partner billing rates and those in the middle of the pack discounted their rates about 14%. More importantly, those in the top quartile collected $384 for each partner hour (85.7% of their average billing rate of $448), compared with $289 for firms in the middle two quartiles (86.1% of their partner billing rate of $336.)

The impact of the firm’s audit practice

For the sixth straight year, the survey found that accounting firms which produce more revenue from audits and reviews are less profitable.

The survey examines profitability based on the percentage of firm fees generated by audits and reviews. The quartile of firms doing the least amount of this work — 8.6% of their total fees, on average — were 34% more profitable than the quartile of firms doing the most audits and reviews (50.7% of their total fees.)

Hylan says businesses have created downward pressure on rates for these services as they strive to contain the cost of audits and reviews, which they view as an operational requirement but not a strategic value. At the same time, increased regulatory requirements and staffing challenges make it harder for accounting firms to complete this work efficiently.

What makes an elite firm?

The Rosenberg Survey also explores what sets apart firms that generate more than $500,000 IPP — which it labels “elite” firms. The key factors, according to the survey, are higher rates and greater leverage, represented by the number of billable professionals divided by the number of equity partners.

The survey also found that:

      • the average staff-to-partner ratio of elite firms is 8.4-to-1 compared with 6.4-to-1 among non-elite firms.
      • average net fees per equity partner are $2.4 million in elite firms compared with $1.7 million among non-elite firms.
      • fees per person are $220,000 in elite firms and $189,000 in non-elite firms.
      • elite firms’ average partner billing rate ($382) is 13% higher than non-elite firms’ average ($339).

Meanwhile, realization, utilization, and billable hours are similar between the elite firms and the non-elite firms, according to the survey.

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