Profits Up At U.S. Accounting Firms

Profits Up At U.S. Accounting Firms

Have profit margins, as measured by equity partner profits as a percent of revenue, been declining at firms over the last 10 years or so?

Albert Einstein said “If I had an hour to solve a problem and my life depended on the solution, I would spend the first 55 minutes determining the proper question to ask… for once I know the proper question, I could solve the problem in less than five minutes.”

The proper question is: Are CPA firms more or less profitable than they were 10 years ago? The problem with the original question is that its author was unaware that “equity partner profits as a % of revenue” can be a weak and sometimes misleading measure of profitability.

Remarkably, CPAs, the gatekeepers of financial measurement and analysis, do not have a proper measure of firm profitability. Two measures are commonly used: Income per equity partner (IPP) and equity partner income as a percentage of revenue. Both are flawed because they are directly impacted by the number of partners in the firm. The more partners a firm has for its revenue size, the more misleading its profitability ratios will be. Conversely, the fewer the partners, the higher the IPP.

CPA firm partners often use both profitability metrics. But profits as a % of revenue is less reliable than IPP, as the following data from The Rosenberg Survey shows:

$2-10M firms:

• IPP=$345,000

• Profit as % of revenue = 33.1%

• Prostaff to partner ratio = 4.4

Over $20M firms:

• IPP = $495,000

• Profit as % of revenue = 30.1%

• Prostaff to partner ratio = 6.8

On the face of it, the above is puzzling. The larger firms enjoy 43% higher IPP but their profit as a % of revenue is 10% lower than smaller firms.

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