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Practice Management Feature: The art of performance analysis

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  • Publish date: 12 January 2011
  • Archived on: 04 June 2015

An article by Alex Brown looking at a firm’s performance, profitability and future direction including guidance on partner accountability and appraisal.

There comes a time in many if not most accountancy practices when the partners decide to take a hard look at the firm's performance, profitability and future direction.

This can be for any number or reasons, for example, retirement of one or more of the senior partners or a merger which has revealed different working practices and cultures on the part of the merging firms.

Whilst the large firms and better run smaller firms will have a management structure which regularly reviews the firm's position in the marketplace and constantly monitors its performance and profitability, this is by no means universal.

The most important element in a performance appraisal is relevant and accurate key data. The manner in which firms keep their financial and marketing data varies significantly.

At one of the scale there might be a computerised practice management system tying in the firm's financial records with its time ledger and marketing data. At the other end, there may be no more than manual records and/or a series of stand-alone spreadsheets.

Whilst it might reasonably be assumed that all firms have records capable of producing financial accounts, the performance of a firm cannot be measured by profit or profit per partner alone. There are a series of key performance indicators (KPIs) which will help reveal the true state of affairs.

These include:

  • Chargeout rates and margins
  • Utilisation of fee earners time, i.e., hours charged
  • Realisation, ie, the percentage of time charged which is billed and recovered
  • Fees per fee-earner and per partner
  • Overheads per fee earner and
  • Lock-up

No in-depth financial review is complete without an examination of the profitability (or otherwise) of individual clients.

As is so often the case in other areas, the 80/20 rule also usually applies to clients, for example, 80% of the firm's client-related problems come from 20% of the clients. These are the clients (and most if not all firms have them) who demand service, haggle over the fee and take an age to pay.

The assignment partner is often reluctant to face up to the situation; the profession's unique asset, for example, the provision of recurring annual services to clients, is also one of its greatest weaknesses.

In the traditional partnership model, recurring fees equal security and even power; witness the unseemly rush for the filing cabinet of the retiring partner as the remaining partners seek to bolster their positions.

The next step

Assuming the practice is not satisfied with the results of a performance review and determines to examine its future strategy, what should it do? It may decide to consult the ICAEW's Practice Advisory Service, it may decide to use one of the recognised consultants in this field, or it may decide to go it alone.

Its decision is likely to be influenced by whether or not it has one or more dynamic partners capable of carrying out a strategic review and implementing any decisions made thereafter.

A thorough review of the firm will examine and establish:

  • Its non-financial strengths and weaknesses. What core and specialist skills do the partners and staff have? How responsive are they to necessary change?
  • The needs of the clients and the extent to which they are not being met.
  • How well or badly the firm is managed.
  • The challenges which the firm faces (competition, new and declining business sectors in its catchment area etc).
  • Those clients which the firm does not wish to continue to advise and those clients and specialist areas it has in its sights.

Management and change

At or about this point in the process of a firm's metamorphosis, it should examine its management structure. The larger the firm the more formal it is likely to already be, but there are still firms where every partner wants his say on every matter and also wishes to retain the right of veto.

Partners traditionally have three roles, those of proprietor, manager (to some degree at least) and fee earner.

Partners in such firms must be persuaded relinquish some of their traditional attitudes and practices to allow the firm to move forward and they need to evolve a structure where they all 'obey' the wishes of the management committee or the majority of the partners.

In short, such firms must, if they wish to maximise profitability, think of themselves as running a business which provides professional services rather than as providers of professional services, the consequence of which is the earning of profit.

Care is needed on the part of the managing team. Significant change destabilises a firm; this can have positive or negative consequences. Furthermore, changes in one area of the firm can have consequences elsewhere and the partners need to be alert to this.

The management team will also be charged with risk management, including in relation to new clients and new service lines.

One critical matter to which that team must pay attention is the firm's reporting systems.

To the extent that they do not provide all the financial and non-financial information needed to run the firm, they must be upgraded. A firm which cannot accurately measure its performance inhibits its progress towards its goals.

The structure of the firm

There is no 'one size fits all' answer to the constitution and structure of an accounting firm. Many new firms and existing firms examining their position have opted for LLP status or corporate status.

Many larger firms have abandoned a departmental structure, replacing it with smaller teams or work groups. The structure should be designed to meet the business needs and aims of the firm rather than constraining them.

Partner accountability

The management team should seek to:

  • Establish the level to which they intervene in what partners do.
  • Establish (or heighten) a business culture and a sense of urgency.
  • Increase partner ambition and performance, including the development of individual partner business plans; and
  • Establish clear lines of accountability for individual partner performance in both financial and non-financial areas.

If partners in accounting firms understand anything, it is cash (drawings and year-end payouts) and cash flow. A successful firm will develop a financial reporting system that highlights the performance highs and lows resulting from each partner's work.

The firms processes must not only monitor individual and team performance, but also focus on cash and debtors, discretionary or unbudgeted expenditure and the use of benchmarks in the budgeting and forecasting process.

The firm should have regular partners meetings, attendance at which is mandatory save in exceptional circumstances. Each partner should have to account for non-adherence to pre-established targets, including time and fees written off (beyond agreed limits) and for client and staff losses.

On a positive note, each partner should also give an account of exceptional profits and client wins. Partners who consistently under-perform must be subjected to some form of sanction.

This may mean oral censure in front of their fellow partners (such sanction preferably to be used sparingly), formal meeting with the management team followed, where appropriate, by a written form of 'warning' or, in the case of partners who respond to nothing else, reduction in or suspension of personal drawings - this is rarely used but can be very effective when it is.

Financial and other dynamics

Financial reporting including KPIs have been covered above. It is the task of management to ensure that the partners are constantly aware of the impact of their actions or inactions on the firm's bottom line.

Other matters which are inextricably linked to profitability (and which cannot be explored in depth in a brief article of this nature) are:

  • Client satisfaction
  • The quality and motivation of staff and partners
  • Staff and partner training
  • Development of a "can do" culture
  • Ongoing marketing and business development
  • The use, in appropriate circumstances of value billing/fixed fees which reflect the value to the client rather than the time input into the matter
  • Investment in new service lines; and
  • A remuneration structure which rewards those who perform and penalises those who do not. The traditional lockstep system of profit sharing does nothing to encourage effort and it should be abandoned. Partners should be taken out of their comfort zone and made to understand that their future income will depend on their future performance as well as on their part performance.

Summary

A firm dissatisfied with its present and past performance can, given the will of its partners, change course and transform itself.

Key factors are the recognition that the firm is in business with a view to profit, tight management (based on good financial and other information) and partner accountability.

Above all however, it is the will to undertake and embrace the consequences of change which separates the successful aspirants from those who do so half-heartedly and ultimately fail.

Alex Brown is vice-chairman of the forensic group of the Institute of Chartered Accountants in England & Wales. He has had 20 years experience in general practice followed by 15 years in forensic accounting. He is a partner with Amicus Forensic. He can be contacted at 020 7430 0333 or e-mailed at browna@amicus-forensic.co.uk