Managing a profitable tax practice; insights into what it takes to build a prosperous practice.
Because tax practice is an important element of most firms, profit management of this practice area is vital. Many factors affect tax practice profit management. Some relate to overall control and organization, marketing or personnel, while others are purely financial, including fee setting, billing and collection and direct and indirect costs of client service. This article adresses some of the more important financial considerations.
Practitioners have many options when setting fees for tax services. Some use one approach exclusively, while others use a number of methods, depending on the type of engagement. Still others calculate fees using several methods and then use an average or the highest or lowest result.
No matter which approach a firm chooses, consistency is very important. If, for example, one taxpayer is billed based on the number and type of schedules contained in the return and another is billed based solely on professional time required to complete the return, the resulting fees may be significantly different for similar tax returns. Inconsistent approaches can confuse or anger clients, prompting them to demand justification of billings, and also can result in lost profits and difficulty in comparing different services to determine their profitability.
Time-base method. With this method, hourly rates must be set for everyone in the firm. There are a number of methods for establishing hourly rates; the professional's experience and ability are two important factors. Once rates are set, each person keeps track of time spent on a project, which is then multiplied by his or her hourly billing rate.
Many firms believe this approach is the most equitable. Billing rates reflect each person's experience and ability, and clients pay for the time required to complete the project. Fees increase when complexities and other issues demand more time be spent on a return.
This method does have some disadvantages, including the administration time required to ensure all the staff is recording time properly. Additionally, fees generated may not totally reflect services because all staff members are not equally efficient. Ideally, billing rates for each individual would take these varaiables into account.
Form-based method. Under this method, charges for tax return preparation are based on the number of forms and schedules included in a return. For example, completing a schedule D may generate a $40 fee, a form 4797, a $50 fee, and so on. The theory is simple: Charges go up as forms become more detailed and complex. One disadvantage is that all clients could be charged the same fee for a schedule D, whether it contained one transaction or many, unless the form charge is based on some type of activity or complexity factor.
This approach may have an advantage over the time-based method when computer processing is part of tax return preparation. Because computers allow many forms to be completed quickly, the time-based method may not accurately reflect many of the complexities involved in preparing a return. For example, preparing an alternative minimum tax schedule can be fairly automatic with a computer. The time-based method might therefore produce a low fee for this schedule, while to form-based method would impose a fairly substantial charge for such a complex form.
Some firms calculate fees using both these methods and bill the highers fee or an average of the two. Even if only one method is used, as should normally be the case, management may want to monitor fees on a sampling of returns using both methods to ensure profits are maintained and to aid in future decisions on fee-setting.
A staff person may use different hourly billing rates on the service performed. The theory behind the multiple-rate approach is simple: Certain projects command a premium billing rate, while other projects merit a lesser rate. Although rates should be based on an individual's experience and the complexity of the tasks, a senior person may complete some tasks that don't merit a highly hourly rate--especially in a smaller firm. For example, the expertise of a partner isn't necessary for payroll tax reports, so clients would be unwilling to pay a partner's higher hourly rate for this service.
Each person is assigned several rates, depending on the task. This usually minimizes or eliminates billing write-downs and adjustments because the rates charged reflect the services performed. For example, an experienced person completing a rather simple task will charge a lower hourly rate.
Salaries should be related to billing rates and overall revenue production so that experienced people are motivated to take on more complex projects and thus grow professionally. Complex tasks such as Internal Revenue Service audit representation and estate planning can command significantly higher billing rates.
Multiple rates require close monitoring to ensure staff members don't use a lower rate for more complex services because they lack confidence, smpathize with a client and so forth. Firms must be sure staff members are completing work and correctly charging professional time. It is usually best to tell staff to record their time and efforts and then let the partners decide how the client will be billed.
Billing realization reflects the difference between the amount billed to a client and the amount of work actually performed and recorded by the firm at standard billing rates. A firm's billing realization policy involves a delicate balance between retaining desirable clients and obtaining fair and necessary compensation for the firm's services.
Firms frequently charge more or less than their standard rates based on factors related to either the client or the services. A firm may bill below 100% because of the client's growth potential or because the firm believes it may be able to offer the client additional services. On the other hand, for example. if a client has had previous tax fraud convictions or is involved in transactions that raise red flags at the IRS, the firm is unlikely to offer the client a discount because of the complexities and risks involved. Another consideration is timing: Firms occasionally are willing to lower their fees for work done in their slow reason. Before a firm discounts a client's bill, however, it should compare the fee with billings for similar clients to ensure consistency.
Billing rates should be set to ensure the firm bills as much as possible of the amount charged by staff at standard rates. This does not mean the firm will have no billing write-downs. Consider the case of a retail store with strict credit policies and no bad debts. While this situation may seem desirable, it may indicate credit policies are far too restrictive.
One approach is to establish billing rates that achieve about a 90% overall realization, and then try to raise realization to 100% by requiring that all billing write-downs and project budgets be authorized by someone other than the person who has done the work. This accountability--to a supervisor, partner or even a spouse--helps achieve fair and realistic realization levels.
ANNUAL FIXED CLIENT COSTS
An important factor in capturing all costs and setting billing rates and tax service fees is the annual fixed cost of serving the client. Most firms incur correspondence and mailing costs for newsletters, yearend updates, tax return worksheets and related materials. File folders and cabinets must be purchased and their contents insured. Data entries must be made and backups of this information must be completed on a regular basis.
This annual fixed cost must be assessed and factored into the fee system. This process helps firms determine if low-fee clients are unprofitable or only marginally profitable in relation to annual fixed costs, although firms must still consider whether such clients are valuable to the firms as referral sources.
CALCULATION OF ANNUAL FIXED COST
Calculating a client's annual fixed cost is difficult. It varies widely because each firm's approach depends on a number of factors. Here's one example of how the cost might be determined:
Newsletters and postage $6.50 Tax organizers and other client worksheets 4.00 File folder and portion of file cabinet 1.00 Annual insurance 1.00 Data processing costs, including file backup and printed material 3.00 Professional liability insurance 4.50 Total $20.00
CPAs may want to vary the cost assumptions depending on the client; they might, for example, set professional liability insurance according to the size and complexity of the engagement. The key issue is to recognize that firms incur an annual fixed cost for each tax client, regardless of the size of the tax return.
Firms might consider adding a fixed charged--$25, say--to the wowk-in-process account for every client at the beginning of each year to cover the yearly administrative costs of retaining the client. Alternatively, they might add $1 or $2 to each professional's hourly billing rate to cover this cost. The amount need not actually be billed, but it does ensure that the work-in-process system captures all costs.
ADDING A NEW CLIENT
A proposal to a new client and the firm's accounting for new client costs are based on a number of considerations. Firms sometime build a discount into their proposals because of the prestige of the client, the possiblity of future referrals or because the client's services will be performed during the slow season. When the client is a law firm or a bank, for example, the relationship can be as important as the job.
At the same time, a great deal of preliminary work often is involved in taking on new clients, such as reviewing prior returns and touring their facilities.
The cost of adding a new client varies from firm to firm, depending on the amount of preliminary work. Some firms immediately add an amount to work-in-process for this cost. Doing so makes it easier to identify worhwhile clients and discourage those that would generate very small fees. For example, if there is a new client fee of $25, it may be difficult to obtain full realization on a tax return fee for a client whose last accountant charged only $75 to $100 to prepare the return. For larger clients, the new client fee is insignificant to the fees they will be charged and will be only a small percentage of overall realization.
TAX RETURN MATERIAL COSTS
A firm also must consider the cost of materials used in tax preparation. In addition to tax organizers, materials such as estimate vouchers, instruction sheets, client copies and tax return packaging materials must be considered. These costs can be built into professionals' rate structures or added to each bill.
Many firms add a standard processing charge ($30, say) to cover material costs and other miscellaneous charges. This charge, which is over and above any computer fees and other direct expenses, is added to the other costs of tax return completion. Many firms vary the processing charge based on the size of the return, reasoning that the material cost is higher for complex returns than for simpler ones.
Competitive pressures are forcing tax practitioners to pay greater attention to profit management. Firms that fail to do so may find profits lagging and client service suffering as a result.
Proper management of a firm's financial affairs entails
* Completing financial budgets and regular financial reports, similar to those prepared for clients.
* Comparing the budget to actual costs, including prompt action to address significant variances.
* Imposing the same rigid financial controls and establishing the same financial budgeting and reporting systems for the firm as for clients.
This article has addressed only some of the factors directly associated with profit management in a tax practice. There are many others, such as minimum fees, comparisons to competitors' and prior year fees, the use of retainers and value billing. Additionally, many indirect factors, such as overall control, personnel management and marketing and practice development, also influence profitability. Practitioners must pay close attention to all of these if their tax practices are to prosper.
ROBERT J. RANWEILLER, CPA, is managing partner of Biebl, Ranweiler & Company, New Ulm, Minnesota. A member of the American Institute of CPAs continuing professional education executive committee, he is coauthor of the AICPA publication Tax Practice Management, from which this article has been derived.
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|Author:||Ranweiler, Robert J.|
|Publication:||Journal of Accountancy|
|Date:||Oct 1, 1990|
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