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Practice Management

Pay Your Staff for Performance

What will make CPAs work hard—for you?

By Robert B. Jr Scott
December 2000

  

EXECUTIVE SUMMARY
  • INCREASING THE PRODUCTIVE, efficient, billable use of each staff member’s time well into the 1,500 to 2,000 hour annual range is the key to a firm’s bottom-line improvement.
  • ANY FIRM THAT BILLS AND COLLECTS less than an average of 2.4 times base salary for staff time should consider a plan based on performance. The plan has three components: a competitive base salary and, when earned, a productivity bonus and a new business bonus.
  • THE PRODUCTIVITY BONUS PLAN provides an incentive to staff members to boost billable time by working productively, seeking additional assignments, spotting opportunities for additional work with existing clients and meeting the budget on fixed-fee engagements.
  • A NEW BUSINESS BONUS equal to 10% to 20% of the first year’s fees from a new client, paid as collected, can stimulate substantial staff interest in practice development. The bonus pays for itself roughly 20 times over—a return on investment of 2,000%.
  • TO SUPPORT THE PRODUCTIVITY BONUS, a firm needs only an additional net-billed-fee summary/worksheet for each staff member each firm fiscal year. It takes less clerical effort than an overtime system does because the calculations are made yearly rather than monthly or weekly.
  • NO BONUS IS PAID when the calculation produces a negative result. A firm should pay the productivity bonus within 30 days of the close of the fiscal year.
ROBERT B. SCOTT, Jr., CPA, is a professor of management at the Gabelli School of Business at Roger Williams University in Bristol, Rhode Island, and a practice strategy and growth consultant. His e-mail address is rbs@alpha.rwu.edu .

ush, you husky,” is meaningful encouragement to sled dogs, but the rest of us need something more. Ask managing partners which incentives best inspire strong staff performance and opinions range across the board. Some practitioners credit cash bonuses as motivators, and others cite the effectiveness of flexible work arrangements, lunchtime yoga classes and office concierges. Still, every CPA knows the bottom-line profits of an accounting firm depend on staff productivity times adequate billing rates—and hard-working staff members who show initiative and use time efficiently are the key.

The typical sole practitioner with more than 10 years’ experience, earning $100,000 to $200,000 per year, will log an average of 1,710 billable hours per year. Another 40 billable hours per year will push his or her firm into the top 25% in profitability in its class.

Source: Texas Society of CPAs’ 1999 MAP survey.

The principle seems simple, but profitability is more sensitive to variations in these factors than many practitioners realize. Because staff members ultimately make the call on how much effort to put into their work, a carefully crafted bonus plan can improve performance by linking staff efficiency to systematically applied rewards. Using the approach described here, large and small firms can attract, retain and motivate the high-quality staff necessary for success in an intensely competitive professional environment.

KEY ELEMENTS OF PROFIT PERFORMANCE

The formula for increasing profits based on revenue from billable staff time starts with the building block of the employee’s hourly wage. A standard hourly billing rate is about .0018 times the employee’s base annual salary, rounded up to the nearest dollar. This yields a $90 per hour billing rate for a staff member earning $50,000 per year ($50,000 X .0018 = $90), consistent with most guidelines in the profession.

Operating statistics for a variety of small and midsize CPA firms and data from the recent national MAP survey published by the Texas Society of CPAs suggest that a typical firm bills an average of approximately 1,400 hours annually per staff member and collects 90% to 95% of that. Expressed another way, the typical practitioner or small firm bills and collects an average of roughly twice salary and fringe benefits annually for each professional employee. Out-of-pocket breakeven is approximately 1.2 times base salary (because of fringe benefits) or 667 standard hours—about $60,000 annually for a $50,000 per year employee.

In exhibit 1, below, collection (the average percentage of standard fees collected for billed time) is presented in units ranging from 100% (ideal) to 60% and compared with a range of billable hours from 2,000 total (ideal) to 1,000 (below average). At 1,400 billable hours with 90% collection, the contribution margin generated by a $50,000 per year staff member is $53,400 (after deducting the $10,000 fringe benefit). Each additional 100 hours of charged time (at 90% collection) generates $8,100 of incremental margin.

Exhibit 1: Staff Contribution Margin (in thousands)
Calculations are based on a $50,000 per year salary; $10,000 per year in fringe benefits; and a $90 per hour billing rate.
  At fee collection percentage
Billable hours 100%     90% 80% 70% 60%
2,000 $120 $102.0 $84.0 $66.0 $48.0
1,900 111 93.9 76.8 59.7 42.6
1,800 102 85.8 69.6 53.4 37.2
1,700 93 77.7 62.4 47.1 31.8
1,600 84 69.6 55.2 40.8 26.4
1,500 75 61.5 48.0 34.5 21.0
1,400 66 53.4 40.8 28.2 15.6
1,300 57 45.3 33.6 21.9 10.2
1,200 48 37.2 26.4 15.6 4.8
1,100 39 29.1 19.2 9.3 (0.6)
1,000 30 21.0 12.0 3.0 (6.0)
Source: Robert B. Scott, Jr.

At 1,400 hours and 90% collection, each percentage point of improved collection yields another $1,260 of incremental margin. The difference between 1,400 hours at 90% collection (just above breakeven) and 1,800 hours at 97% is $43,740 of additional margin—that’s profit—on one $50,000 staff member.

Increasing the productive, efficient, billable use of each staff member’s time well into the 1,500 to 2,000 hour annual range is the key to a firm’s bottom-line improvement. It is easier said than done, of course. In a strong job market, salary buys compliance only with minimum work standards, and employees can shrug off demands they find excessive. Overtime pay rewards hours clocked—maybe even inefficiency—not performance. Discretionary bonuses often are arbitrary in nature and influenced by personal factors; many employees resent them. There is a way to make your staff care, though—by systematically linking their extra effort to a cash reward.

PERFORMANCE-BASED COMPENSATION

Any firm that bills and collects less than an average of 2.4 times base salary for staff time should consider a plan based on performance. The plan costs nothing unless a worker’s revenue exceeds that worker’s cost plus a fair contribution to overhead and some partnership profit. Bonuses are paid out of incremental profits. The plan has three components:

  • Competitive base salary.

  • Productivity bonus.

  • New business bonus.

Each staff member is paid a competitive base salary and, when earned, a productivity bonus and/or a new business bonus. Here’s how to mesh the elements of the plan.

Base salary. Make each staff member’s base salary competitive with quality firms in the practice area. Don’t make the mistake of trying to substitute bonuses for base salary. Bonuses always should be in addition to competitive salaries; otherwise, they don’t offer staff members additional incentive. Continue to make annual adjustments to base salary exactly as if there was no bonus program.

Productivity bonus. Pay each staff member an annual productivity bonus based on this simple formula, applied to each staff member individually: net fees billed for staff member’s time, minus staff member’s base salary multiplied by 2.4, divided by two. It looks like this—

Productivity bonus = Net fees billed – (2.4 X base salary)
  2

Here’s what it boils down to: A $50,000 per year staff member whose billing rate is $90 per hour gets to keep half of everything she generates over $120,000 ($60,000 equals her salary plus fringe benefits; $60,000 is the firm’s). Two thousand billable hours will bring in $180,000, of which $60,000 is performance-based revenue. The productivity bonus splits fees in excess of 2.4 times base salary with the staff member on a 50/50 basis and earns her a $30,000 bonus—she gets half of the gravy (see exhibit 2, below).

Exhibit 2: Effort Times Hours Yields Dollars
Calculations are based on a $50,000 per year salary; $10,000 per year in fringe benefits; and a $90 per hour billing rate.
Net fees Standard hours Bonus Bonus % Compensation** Contribution Contribution %
$72,000 800          $0  0%    $50,000       $12,000    17%        
90,000 1,000          0       50,000       30,000    33           
108,000 1,200          0       50,000       48,000    44           
126000 1,400          3,000  6       53,000       63,000    50           
144,000 1,600          12,000  24       62,000       72,000    50           
162,000 1,800          21,000  42       71,000       81,000    50           
180,000 2,000          30,000  60       80,000       90,000    50           
198,000 2,200          39,000  78       59,000       99,000    50           
*Based on hours at 100% collection.
**Does not include fringe benefits (assumed to equal 20% of base salary) or new business bonus.
Source: Robert B. Scott, Jr.

Exhibit 3, below, graphically illustrates productivity bonus results at various levels of staff activity for an individual staff member with a $50,000 base salary. The revenue value of various levels of billable standard hours is presented in amounts ranging from $50,000 (unsatisfactory) to $150,000 (good); and bonuses, bonus percentages, compensation, contribution margin and percentage contribution margin are depicted.

Exhibit 3: Charting a Staff Member’s Enterprise Zone
Calculations are based on a $50,000 per year salary; $10,000 per year in fringe benefits; and a $90 per hour billing rate.
Individual staff member cost-volume-profit analysis

Source: Robert B. Scott, Jr.

The plan pays nothing for average or slightly above average performance, such as when the $50,000 per year employee generates less than $120,000 in fee revenue for the year—the equivalent of 1,333.33 standard hours at 100% collection. However, above that level the bonus plan begins to provide a powerful incentive to staff members to boost billable time by working productively, seeking additional assignments, spotting opportunities for additional work with existing clients, meeting the budget on fixed-fee engagements and otherwise working in ways that serve the interests of their employers.

For example, at 1,600 standard hours an employee with a $50,000 base salary and a $90 billing rate (see exhibit 2) will generate 1,600 X $90, or $144,000 in fee revenue: $144,000 – ($50,000 base salary X 2.4) = $24,000 of fees in excess of 2.4 times base salary. Splitting this amount evenly between the firm and the employee results in a $12,000 bonus (24% of base salary) to the employee and a $12,000 profit increase to the firm. At 1,800 standard hours, or $162,000 in fees, both the bonus and the profit increase rise to $21,000. Contrast this with straight salary, salary plus overtime, salary plus arbitrary bonus or other compensation schemes traditionally used in the accounting profession. How would you prefer to be paid?

The productivity bonus approach makes it possible for profits and staff compensation to increase by equal amounts simultaneously. Because the firm retains half of the gain and pays the other half as a bonus, in effect staff members “earn” their bonuses twice over. The method doesn’t have a down side, although it does require firm owners to share profits with employees. Owners reluctant to do so may think compensation is a zero-sum (if you get more, I get less) game. However, a plan such as this can put additional money in everybody’s pocket by increasing the size of the profit pool. It is simple and fair: You pay for results, not promises.

NEW BUSINESS BONUS

A new business bonus equal to 10% to 20% of the first year’s fees from a new client, paid as collected, can stimulate substantial staff interest in practice development. Such a bonus amounts to splitting the profit on a new client, for one year only, with the staff member who brings the business in the door. Used in conjunction with the productivity bonus, a new business bonus can help staff members to think more like practice owners, in the sense of always looking for new clients and more efficient ways to do things. Staff members who appreciate the financial dynamics of the profession also recognize the need for growth, staff training and high staff utilization. However, if you use artificially low first-year fees to obtain new clients, a new business bonus isn’t practical for your firm.

A 10% new business bonus to a staff member amounts to 5% or less of the net present value of the profits on a client that lasts five years. So if offering the bonus results in a new client that lasts five years, the bonus pays for itself roughly 20 times over—a return on investment of 2,000%. And since it is a “no new clients, no bonus” policy, there is zero risk. It’s like betting after the race is over. Even if the client leaves after a single year, the return is more than 400% in most practices.

ADMINISTRATION

Assuming that the firm has an accurate and timely client billing procedure and that the firm’s fiscal year-end falls during the slow season (avoiding cutoff and similar problems), administration of an incentive plan of this type is not difficult. In fact, it takes less clerical effort than an overtime system does, since the calculation is made once each year. Administration of the productivity bonus requires only preparation of a net-billed-fee summary/worksheet for each staff member each firm fiscal year. The new business bonus is based directly on collections from new clients and is easy to compute and pay.

As jobs are closed out (final billed) for the year, the administrative partner or manager determines the net-fee collection percentage and the net billed fee attributable to each staff member who worked on the job. (Staff net fee collection percentage times an individual staff member’s accumulated standard time charges for a job equals the net billed fee earned by that staff member on that assignment.) The net billed fee earned on each job is posted to the staff member’s net-billed-fee summary/worksheet.

At year-end the staff member’s net-billed-fee summary/worksheet provides the basis for calculating his or her productivity bonus. (No bonus is paid when the calculation produces a negative result.) Remember, under this plan, employees have been exerting themselves for months to reap the benefits of their good performance, so pay the productivity bonus within 30 days of the close of the firm’s fiscal year.

A firm that wants to offer meaningful incentives to inspire staff performance should consider the productivity and new business bonus system: “Cash, anyone?”

Practitioners Talk About Compensation

Staff compensation is a frequent topic of discussion among CPAs.
Three experienced practitioners share their views.

Charles Rae, Jr.
Rae & Co., Fishkill, New York
RaeCPA@worldnet.att.net

Charles Rae has been a CPA since the early 1970s, working in large and small public accounting firms as well as in private industry and education. Rae started his own firm in 1978 and believes retaining quality employees is a paramount challenge every firm faces in an increasingly competitive environment. He continues to look for better ways to reward staff excellence.

“The biggest obstacle for some firms is psychological,” says Rae, who has always been comfortable with an incentive policy. “Not everyone wants employees to participate fully in profits and benefits, which is a 1960s perspective.” Tax staff at Rae’s firm can earn bonuses based on tax return revenues they produce. Additional tax professionals are being recruited, and supervisors will be able to earn piggyback bonuses based on revenues generated by junior staff. “I want to encourage good use of newer staff,” Rae says.

Rae, who thinks C corporations provide the widest range of opportunities for advantageous tax treatment, plans to form such an entity. The firm will transfer all tax preparation functions to it, offering tax-free benefits such as medical and travel reimbursement, pensions and cars to his employees. “It will reduce my dollar outlay and put more in the employees’ pockets,” he says.

Depending on how developed a practice is, Rae thinks other compensation components, can work well. Deferred bonuses for remaining with the firm for a stipulated period of time encourage new staff to stay put. The bonus formula described in the article spurs hard work and new business development for a young practitioner starting his or her firm. Older practitioners contemplating retirement may wish to defer payment of a portion of bonuses earned under a plan to encourage staff retention until a retirement game plan is securely in place. “Every practice is different,” says Rae, “so there’s no standard formula.”

Margaret Bellucci
Black Point Associates, LLP, Brookline, Massachusetts
mmbell745@aol.com

In 1992 Margaret Bellucci, CPA and partner of a firm, teamed up with Mary Thornton, a former registered nurse with an MBA, to establish Black Point Associates, a cross-disciplinary firm offering high-end consulting services to the behavioral health industry. They first focused on strategic planning, efficiency and cost studies, but industry concerns and their own professional instincts soon led them into the burgeoning field of regulatory compliance assistance. The 1996 Health Insurance Portability and Accountability Act (HIPAA) created a wealth of compliance concerns. Bellucci and Thornton recognized a fresh professional market and moved quickly. Along the way, they had growing pains.

In 1997 Bellucci and Thornton added three experienced partners to the team: an IT specialist, a PhD psychologist and a generalist/strategic planner. Black Point Associates became a high-powered “boutique” with a loose organizational structure and no administrative staff. Each partner was supposed to market his or her skills and the firm overall, and was to be paid based on the revenue generated. That was the theory. “It was a total failure,” says Bellucci. Some partners couldn’t market well and couldn’t understand the entrepreneurial model—they expected work to be handed to them as if they were employees. One by one, the partners bailed out.

On their own again, Bellucci and Thornton searched for a joint-venture partner to complement their strengths. It took 18 months to locate psychologist Derek Jansen. After working on a trial basis, Jansen was invited to join Black Point as a partner.

Bellucci is a specialist in federal cost accounting compliance and administrative matters. Thornton is the operations guru and author of a popular book on behavioral health industry regulatory compliance strategies. Jansen combines professional knowledge of behavioral health services with a thorough understanding of billing, coding, and service documentation standards. Their client-base is nationwide and growing.

The current organization and compensation scheme is simple. Billing rates range from $1,500 to $1,900 per day. Bellucci and Thornton keep 90 percent of their time charges, as collected, as compensation. The rest stays in the firm. Jansen, who is purchasing an equal interest in the firm, retains a lower percentage, which will increase as his ownership interest grows. Compensation is based on individual engagement charges, motivating each partner to seek new engagements.

The next challenge, according to Bellucci, is to leverage the strengths of Black Point by adding layers of professional staffing without sacrificing the sense of “new era” entrepreneurial success currently enjoyed. Bonus compensation will be part of the new growth. “This is a compatible and successful team,” she says. “We have a real opportunity to think about the value each of us brings to the firm and to structure our roles and compensation for the future.”

Stephen Fay
Fay & Associates, PC, Quincy, Massachusetts
smf@faycpa.com

Steve Fay started his practice in 1996, after leaving a partnership position with another firm. A CPA with a law degree, Fay is proficient in a broad spectrum of auditing, accounting, tax, estate and management consulting areas. He knows his success depends on an excellent staff, and their success depends on him.

“We’re all in this together,” Fay says, “and that has to be reflected in the compensation structure.” Employees at Fay & Associates, PC, participate in a 401(k) plan featuring a 50% matching component as well as profit-sharing and new business bonuses. The new business bonuses are discretionary rather than formula based. “Some new clients simply are more valuable to the firm than others,” says Fay. “And more than one staff member may be involved in bringing them in.” For example, a new $40,000 client typically will generate a 10% to 20% bonus, which might be paid to one staff member, split among several or added to the profit-sharing pool.

Fay’s key bit of advice for other practitioners: “Give staff a sense of ownership. Employees need to feel that they are being compensated as if they were owners. If they bring in profitable business that enhances the bottom line, they should be rewarded.”

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