Pay Your Staff for Performance

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 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.

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—

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 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?”