Key performance indicators for professional services firms
As accounting professionals, our area of genius is bank reconciliations, workpaper tie outs, and financial statement preparation and analysis. When accountants run their own firms though we have to wear the business owner hat at least half of the time. This article shares what we here at T&O learned over the last few years running our own separate practices as professional services businesses and how we measure our performance.
If you read our new blog on accrual accounting, it will come as no surprise that we use accrual accounting in our businesses, meaning we recognize revenues when earned and expenses when incurred. The reasoning is two-fold. First of all, we are a lot more comfortable with the accrual method of accounting (occupational hazard), but the bigger reason is that it allows for a more accurate representation of the financial performance. It also allows for more meaningful comparisons between different accounting periods, since income and expenses are recognized consistently over time.
If you are going to be budgeting, forecasting or creating any financial models, or would like to have your financials serve their purpose of aiding you in business decisions, we encourage you to consider switching to accrual method for internal reporting purposes. In fact here at T&O, we assist clients in switching to accrual method for book purposes precisely for this reason.
When it comes to reporting, we use classes in our own books which is a feature available to QuickBooks Plus subscriptions and above if that’s your accounting system of choice. Class tracking allows to categorize revenues by different income streams-such as tax, monthly accounting, and advisory services, for example. All income and expenses have a class associated with them. Running the Profit and Loss Statement by class provides a more granular level of detail and informs us better when it comes to the 3 distinct income streams. For example, for the sake of argument, if the overall profit margin is 50% but the tax revenue stream has a profit margin of 65%, I might want to focus on increasing my overall tax revenue to grow my bottom line. By segmenting revenue in this way, firms can gain valuable insights into which areas of their business are most profitable and where improvements are needed. For example, a law firm may categorize its revenue by practice area, allowing them to determine which legal services generate the most income. This information can guide resource allocation, marketing efforts, and strategic decisions.
We talk about net, operating and profit margins in this blog, so I won’t go into too much detail here, but our reporting is created in a way that makes it easy to isolate these 3 important KPIs.
Fundamentally, analyzing the gross and net profit margins is an exercise in pricing and expense management strategies. There are three ways in which your bottom line will grow-growing your customer base, increasing price or cutting costs. Sometimes, cutting costs can only take you so far and to scale, you do need to outsource some of the client work, so having a good handle on the gross and net margins, will allow you to analyze not just the expense side of things, but focus on proper pricing for services.
Customer Acquisition Costs (CAC) is another great KPI which calculates the expenses incurred to acquire new clients. For professional services firms like ourselves, CAC includes marketing, sales, and lead generation expenses. Calculating CAC is crucial in determining the return on investment for client acquisition efforts. To calculate CAC, divide the total acquisition expenses by the number of new clients acquired during a specific period. Monitoring CAC helps us assess the effectiveness of our marketing and sales strategies and allocate resources appropriately as well as pivot our strategy based on the results.
Customer Lifetime Value (CLV) is defined as the estimated total revenue a firm expects to generate from a client over their entire relationship. CLV is a critical KPI because it quantifies the long-term value of acquiring and retaining clients. To calculate CLV, multiply the average annual revenue per client by the expected duration of the client relationship. By understanding CLV, we can make informed decisions about client retention strategies, pricing, and resource allocation. Since we are a service-based business, this customer-centric metric ultimately is responsible for creating a great customer experience. Price isn’t everything, as we all know, and client retention is key to long-term success.
While this isn’t an exhaustive list of KPIs we track as a professional services firm, it highlights the ones we love the most.
If you are struggling to measure your performance, we are always here to help! Get started with us today!