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Firms are focused on assessing how they are ending the year financially and how next year is going to look. One key variable in the assessment to help determine where your firm is (and where you are going) is to perform a Pareto Analysis. I’m surprised at how many firms DO NOT perform the analysis.
Let’s start out with a few definitions:
Underperforming clients: Clients that are below your target average hourly charge rate ($175 is a good number to target) or Gross Profit Percentage (75%). Please note that high realization doesn’t mean profitable. It means high realization. Put another way, if your charge rates are low relative to the cost of your labor you could still have high realization and generate very little profit. Many firms utilize much of their capacity servicing clients with high fees but low profitability (as measured by Average Hourly Charge Rate or Gross Profit).
Best clients: Clients where you are achieving your target average hourly charge rate/Gross Profit or higher. The clients provide you and your team with challenging work, value what you do, they are growing and refer more business (like them) to you.
Our suggestion is you perform a Pareto Analysis (smart guy check him out on Wikipedia) to see where you are generating above average profit and where you are “just busy.” Please don’t confuse busy with profitable (many firms do).
Here’s how you do it:
Export your client list with respective Revenue, Profit, Cost and Average Hourly Charge Rate and sort away.
The premise is simple, 20% of your clients generate 80% of your profits. Sometimes the numbers are astonishing. Two recent cases come to mind – 2% of revenue coming from 49% of clients. And, another way of looking at things in a separate firm, 2% of revenue generated by 270 clients! The problem is, the true cost of servicing those lower priced clients is almost always higher than you think. In most firms we find it’s around 30/70. Nonetheless, still a sizeable number that has all kinds of business model implications. Business model implications meaning clients drive costs (including driving qualified team members out of the profession).
You will find it very enlightening to view your firm in this way. It’s always eye opening to see that some clients are generating $300 per hour and others $100. The question is why and what can you do about it?
The next step is to start looking at ways to upgrade your clients. We personally aren’t big advocates of firing clients straight away. We believe you should give them a chance to stay with the firm on your terms. As an aside, we find far too many firms let their clients dictate the terms of the relationship.
Further, Partners should only be handling A and B class clients. In most cases if A class clients are being properly serviced they will realize at least $25K in fees each year. So you should limit to around 20 A class clients per partner.
Incidentally, when you are talking with potential A class clients (who may be either existing B class clients or brand new clients to the firm) partners have found it very helpful to position themselves well by indicating that ‘I only work with a small number of clients in this intensive way at any point in time and I am very particular about who I take on.’
Pareto in Action
Here are the key numbers of a Partner in a firm we work with:
500 # of Clients
118 # of Clients with a Gross Profit of greater than 70%
The result of having a number of underperforming clients is you have made a choice to have increased overhead (team members to support the clients) and working increased hours for less profit. The opportunity cost is less time to pursue better clients, spend time with A clients or spend time on leisure activities.
As explained, the Pareto is a very powerful exercise to perform and action with your team. The worst thing that can happen is you find out where you are making money? Isn’t that what you should be doing as an accountant after all?