When you run an accounting firm, you spend most of your time helping other companies and individuals manage their finances. But you also have your own business to worry about.
In order to evaluate the overall health of your firm, you need to dig in and examine financial metrics such as profitability.
Five Ways to Measure Profitability
You might have a nice one-liner on your website that talks about how you’re in the business of helping other people succeed, but to be honest, you’re in the business of making a healthy profit.
The moment your accounting firm ceases to be profitable is the moment it will collapse. But do you know how to measure profitability in your firm?
There are more than a dozen different formulas you can employ to measure your accounting firm’s profitability, but they can all be categorized under two basic headings:
- Margin ratios.
- These represent a company’s ability to convert sales into profits.
- Return ratios.
- These represent the firm’s ability to generate a return to its shareholders.
Most likely, your accounting firm is going to focus on margin ratios. Here are some options.
- Gross Profit Margin
This is one of the most valuable and accurate indicators of profitability. However, since it’s highly dependent on measuring the cost of goods sold, it’s typically applied to the sale of physical goods. The formula looks like this:
Sales Revenue – Cost of Goods Sold = Gross Profit
You then take your Gross Profit and insert it into the following formula:
Gross Profit / Sales Revenue = Gross Profit Margin
The higher the percentage, the more profit you’re keeping with relation to the input costs. Lower percentages usually indicate lower profitability, but that can be acceptable … so long as your sales volume is high.
- Operating Profit Margin
This equation is more appropriate for accounting firms. It analyzes earnings as a percentage of sales before income taxes and interest expenses are deduced.
Companies that have a high operating profit margin can typically pay for fixed costs and interest more readily. This signals better health and a higher chance of survival during recessionary periods.
Start by calculating your Operating Profit:
Sales – COGS – Operating Expenses – Depreciation and Amortizations
Then the equation looks like this:
Operating Profit Margin = Operating Profit / Total Revenue
In essence, your operating profit margin tells you the percentage of operating profits derived from the total revenue. If you have a 20 percent operating profit margin, it means you produce $0.20 of profit for every $1 of revenue.
- Cash Flow Margin
The cash flow margin measurement focuses on the relationship between cash flows from operating activities and sales that are generated by the company. It essentially represents your firm’s ability to convert sales into cash.
Cash Flow Margin = Cash Flows from Operating Activities / Net Sales
The higher your percentage, the more cash you have available to cover costs … and the healthier your accounting firm is.
- Net Profit Margin
The net profit margin calculation is all about identifying what percentage of your sales is profit. However, it’s often more valuable than the gross profit margin, because it’s calculated after all the cost of goods sold, operating costs, and taxes are taken out.
The formula looks like this:
Net Profit Margin = Net Income / Total Sales
The higher the margin, the more of your net income turns into profits. A 22 percent net profit margin indicates that 22 percent of your total sales revenue is profit.
- EBITDA Margin
The EBITDA margin is one of the most commonly used profitability measurements. It’s essentially a ratio that measures how much of your accounting firm’s earnings are being generated before interest, taxes, depreciation, and amortization.
It’s expressed as a percentage of revenue. The first part of the equation looks like this:
EBITDA = Operating Income (EBIT) + Depreciation (D) + Amortization (A).
Once you have that figure, you can calculate the ratio using the following formula:
EBITDA Margin = EBITDA / Net Sales
A low EBITDA indicates profitability problems, as well as cash flow troubles. A higher EBITDA margin shows stability in earnings.
Additional Questions to Ask
In addition to crunching the numbers with the previous five formulas, you should also ask yourself two vital questions:
- Do my clients return?
- In other words, are your customers coming back consistently, year after year? If so, you’re doing something right. It also indicates you’re getting more value per client, which means a lower client acquisition cost.
- Are my clients happy?
- At the end of the day, are your clients putting up with you because they have to, or are they genuinely satisfied with the services you’re providing? If they’re honestly pleased, this represents an opportunity to extract more value from them.
The answers to these questions—combined with the objective data from the mathematical formulas above—will give you a pretty clear idea of how you’re doing.
How to Boost Your Accounting Firm’s Profitability
Not satisfied with your profitability? Believe there’s still more meat on the bone? Here are some simple ways to begin boosting your numbers:
- Identify Your Most Valuable Clients
Can you identify your five most valuable clients? What about your 15 most valuable clients? Now think about what they have in common.
Your most profitable clients are living, breathing frameworks. Figure out how to replicate them while sloughing off the clients that waste your time and other resources. You’ll see your profitability climb with minimal increase in effort.
- Increase Referrals and Word of Mouth
Every dollar you have to spend on advertising and lead generation is a dollar less profit for the business. The best way to continue bringing in new clients without also raising your expenses is to obtain more referrals and word of mouth.
Sometimes all it takes is a simple request to get a referral. Start with your most satisfied clients and see what kind of response you get. You can also offer an incentive program, but be careful not to give up too much in return.
- Enhance Invoicing Processes
Invoicing can be a nightmare for many accounting firms. If you can find a way to make your invoicing processes more efficient, you’ll generate greater income more quickly. This boosts your numbers and cuts the number of accounts you’ll have to send to collections.
- Eliminate Unbillable Hours
Find those projects, clients, and processes that result in unbillable hours for your team. Meetings are an example.
If you’re calling a bunch of meeting throughout the week, you’re limiting the number of hours your partners and staff can bill clients. Try to leave schedules as open as possible.
- Upsell Existing Clients
Find a way to upsell services to your existing clients—especially the ones who are happiest and most pleased with your services. The easiest and most valuable upsell is from tax preparation services to accounting advisory (or some similar service).
Any time you can take a client who pays for your services only once a year and transform that money into a steady drip of revenue throughout the year, you’ll be doing good.
Outsource With Taxfyle
Maximizing profitability requires total operational efficiency. During the busy tax season, it’s easy to get bogged down handling lots of smaller clients.
Rather than turn them away, you can transform your firm digitally and free up staff time by leveraging Taxfyle’s real-time onshoring platform. We have a network of more than 1,300 CPAs and EAs ready to serve you and your clients without any upfront cost. Request a demo to learn more!