What is Tax Accounting? Everything You Need to Know
For United States citizens earning income, tax accounting is unavoidable. But what is it?
Why does your accounting firm exist? In other words, what makes you show up to work every morning with a cup of coffee in hand and burn the midnight oil late into the night when you should be in bed watching Netflix?
At first, you’re likely compelled to answer these questions with some pre-packaged sound bite like, “We work hard so that our clients can continue building meaningful businesses that change the world.” While little platitudes like this sound good the surface – and there’s a part of you that really should be striving to add genuine value to the marketplace – don’t fool yourself into thinking you work long, stressful hours so that you can save the world and better mankind.
The reality is that your accounting firm exists to generate revenue. But even more specific than that, it exists in order to generate profits so that you and your partners/employees can pay bills, support families, build wealth, and live comfortably.
If you aren’t focusing on accounting firm profit margin, you’re missing the mark. Not only are you doing yourself a disservice, but ironically, you’re also limiting the amount of value you bring to your clients.
Thankfully, with just a few simple tweaks, you can dramatically increase your profit margins and spark change.
The formula for net profit margin – which is the type of profit margin we’ll be referring to in this blog post – is pretty straightforward. It looks like this:
Net Profit Margin = (Net Income / Revenue) x 100
While every accounting firm is unique, you’ll discover that many firms have trouble crossing a certain threshold of profitability. Each year, the AICPA conducts a survey of its small CPA firms. Here’s what the limited data shows:
Firms with revenues of $196,643 average $76,571 in profits (38.9 percent).
Firms with revenues of $371,432 average $149,477 in profits (40.2 percent).
Firms with revenues of $671,880 average $271,129 in profits (40.3 percent).
As you can see, the actual revenue and profit numbers may change, but the profit margin remains relatively steady across the board. Regardless of whether revenues are under $200,000 or close to $700,000, it seems as if small accounting firms have great difficulty in surpassing 40 percent profitability. And this is obviously a missed opportunity.
Increasing profit margin is all about doing more with what you have. It’s not enough to increase revenues. If revenues only increase proportionally with profits, you’ve done little more than increase the amount of work on your plate. The goal should be to increase revenues and profits disproportionally (with profits increasing at a larger percentage).
Or, if you feel so inclined, you can maintain your current revenues and find a way to generate more profits with what you have. Either way, profits need to account for a larger percentage of the pie. And believe it or not, it’s not as impossible as it may seem.
On the surface, improving accounting firm profit margin is relatively simple. According to Rob Nixon, who has worked with dozens of international accounting firms to tackle this challenge of profitability, there are really only three levers you can pull when optimizing to enhance profit margin:
The first key is to increase profits. When most firms hear this piece of advice they automatically assume that this means increasing billable hours, but this isn’t the answer. Ultimately pricing needs to be more efficient.
More efficient capacity.
Capacity – also known as “turnaround time” – is very important in getting more work done and benefiting from healthier profits numbers.
As profits grow and capacity increases, there’s a major opportunity to drive up revenues by attracting more of the right clients.
Now, underneath each of these categories are dozens of small and large actions firms can take to improve. We’re going to take the time to highlight some of these techniques in the hopes that a couple of them will spur you on to make some positive changes inside your own accounting firm. Take a look:
1. Adjust Your Pricing Structure
Begin by considering your current pricing structure and reevaluating how you approach this sensitive, yet important issue.
First off, if you’re still pricing by the hour, you need to stop. This is one of the biggest mistakes accounting firms make and it has a dramatically negative impact on profit margins. When you charge by the hour, you’re essentially putting your business in a position where [time] = [money]. Unfortunately for your firm, there’s a limited supply of time. And in order to make money, you have to contribute a proportional amount of hours. Want to increase revenues by 10 percent? You’ll need to put in 10 percent more time. (This quickly becomes an unsustainable model.)
Instead of an hourly pricing structure where your margins are directly dependent on your time input, you should charge on a value/project basis. Not only does this allow you to earn more revenue in less time, but it can also motivate your team to work smarter.
2. Eliminate Low-Value Services
Every accounting firm has a handful of services they offer clients. If you’ve never taken the time to carefully study each of these services, you may not realize just how much discrepancy there is in ROI from one to the next. Some services yield an extremely low value, while others generate robust profit margins.
The best way to evaluate your services is to take the value of the invoice and divide it by the amount of time it takes to complete the project. As you do this for dozens and hundreds of projects, you’ll start to identify which ones are low-value services and which ones are high-value services. Armed with this information, strip out the low-value offerings and focus your energy and efforts on high-value services.
3. Remove Operating Inefficiencies
What sort of operating inefficiencies do you have within your accounting firm? If you can’t immediately name three or four, it’s only because you aren’t digging deep enough.
Think about your business processes, the tools your team uses, the ways in which you communicate (internally and externally), how you record and organize data, etc. Simple tweaks in these key areas can produce significant change – particularly when you move from an hourly-based pricing structure to a value/project-based pricing structure.
4. Upsell Existing Clients With Advisory
When most firms want to improve their revenue and profit numbers, they intrinsically gravitate toward bringing in new clients. However, the truth is that it’s far more profitable to upsell a current client.
If you’re currently only offering isolated services to your clients, now’s the time to expand your horizons. Try upselling your tax prep clients with ongoing bookkeeping and payroll services or even advisory offerings. You’ll see profitability tick up.
5. Bring on the Right New Clients
While it usually makes more sense to upsell an existing client, there is a time and place for bringing on new clients. The key is to choose your clients wisely. Hone the skill of being able to identify which prospective clients are worth your time and which ones will require too much energy and micro-management. You want clients that are organized, responsible, proactive, and honest. If you sense a client lacking in any of these areas, it may be better to move in another direction.
At Taxfyle, we understand the challenges that accounting firms face when it comes to profit margins and operating efficiency. That’s why we’ve designed a system that helps firms offset busy work, increase turnaround times, and free up staff to work on the most important accounts.
Contact us today to learn more about out tax preparation outsourcing services and how they can help you amplify profitability!
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