The CPA Firm Business Model (#372)
/The topic of this episode comes from a listener, and it is, please talk about the billable hours model of CPA firms. Do you think that is what’s preventing people from becoming CPAs? Do you think billable hours are an employee surveillance tool? Having enough billable hours and staying within budgeted hours causes me enormous stress. End quote.
Well, that certainly covers the experience of a lot of new auditors! To respond to that, I’ll describe the business model of a large audit firm. Then you can see why new auditors are under so much pressure.
The CPA Firm Business Model
The sole focus of this business model is how much money an audit partner can make. And believe me, they make a lot of money. In order to make that money, they have to tweak how their organizations operate. This involves a couple of changes that put a lot of pressure on their employees. One of these changes is a billable hours goal. When I worked for Ernst & Young, the audit partners came back from one of their retreats and proclaimed that everyone had to work an average of ten billable hours per working day. I have no idea what that number is now, but the main point is that any auditor is going to be reminded – frequently – that they need to meet their billable hours goal. This can be really hard, unless you want to work late and on weekends.
The second point is that you can’t just record any old hours against a client account. You have to charge hours that are actually billable. There’s always a cap on how much of a fee clients are willing to accept without a lot of pushback, so the audit partners want their employees to charge roughly as many hours as were charged against an audit job in the preceding year. If they charge more than that, then the excess is maybe not revenue for the firm, and the partners don’t make as much money.
Therefore, and on top of meeting a billable hours goal, you also have to be efficient. This is really hard for a lot of new auditors who are fresh out of school. They know about accounting and auditing in theory, but they haven’t seen it in practice before. So the expectation to get up and running right away, and also meet a billable hours goal, can be quite a shock. This is why a massive number of new auditors quit in their first year. They find that they can’t be both efficient and billable all at once. It’s not impossible, but it’s designed to be really hard.
Which brings me to the third part of the business model. The focus in a large audit organization is up or out. There’s a very specific promotion path, where you have to be promoted into the next level every year or two, or else you’re counseled out. This occurs at all levels, including at the partner level. And even if you’re a successful partner, you’ll still be forced to retire, once you reach the mandatory retirement age. And yes, they have to force out nonperforming partners in order to make room for new partners. If you have too many partners in the business, then the profits have to be split among too many people, and that does not maximize the profits that each partner receives.
For example, you might have worked hard for years, make it all the way to senior manager, and then get hit with a new goal, which is to bring in new business. If you can’t generate the revenue – and it’s not easy – then you’ll eventually be pushed aside, to make room for someone coming up behind you. And, what if you do make that revenue target? Then you get promoted to junior partner, rather than full partner. Why is there such a position? Because it puts one more layer between you and the pot of gold that’s paid out to the senior partners.
Exceptions to the Rule
There are a few exceptions. If someone is an amazing specialist in one or two areas, then they may be kept there. For example, my wife turned down a promotion to senior manager for five consecutive years. She kept turning it down, because her billing rate would go up by so much as a senior manager that she knew she wouldn’t be able to generate enough billable hours. She was a really good project manager, so they let her stay where she was. Eventually, though, she was forced to take the promotion, and only lasted another couple of years before her billable hours dropped enough that she just couldn’t stay there any longer. She wasn’t forced out, but she was extremely unhappy. And, there were quite a few nights when I’d have to tell the kids that mommy couldn’t read them a bedtime story, because she was still at work. A few times, she got home at one o’clock in the morning. So, she eventually resigned. And there you have a real-life example.
Nonetheless, the up or out process applies to nearly everyone, and the point is to make sure that there’s always a constant stream of fresh blood coming up through the organization. And somewhere in that new group will be a few people who take to auditing right away, and who are willing to put in the hours to be sufficiently billable, and who can eventually bring in new business, too. As for everyone else, you’re out of luck.
And that is the audit firm business model. You force people to be extremely billable, you weed out the ones who aren’t efficient, and you dump nonperformers to make room for new people.
Why People Still Work at CPA Firms
This sounds brutal, and it is. Why would anyone put up with this crap? The reason is pretty simple. Working for a major audit firm is a big item to have on your resume. If you last a couple of years, then that gives you a big advantage in getting a mid-level accounting job in the private sector. If you can make it to audit manager and stick around another year or two, then you can probably pick up a controller position at a client. Or, if you bail out as a senior manager, it’s not unreasonable to expect a CFO position to open up for you somewhere else. In short, everyone knows the system is rigged against them making it all the way to partner, but they all put up with it anyways.
Does the Business Model Reduce the Number of CPAs?
Now, let’s go back and address a couple of other items that the listener brought up. Does this system prevent people from becoming CPAs? Yes, of course it does. A lot of people quit in the first year – usually about twenty percent of the new hires – and most of them never want to come near the profession again. So in their case, the experience drives them away from the CPA certification. Even if they already passed the CPA exam, they simply have no interest in being a CPA anymore, and they’re not willing to stick around long enough to complete the experience requirement.
Are Billable Hours a Surveillance Tool?
Now, let’s address that other listener question, which is, do you think that billable hours is an employee surveillance tool? Not exactly. It helps to understand how you’re assigned to an audit job. There’s usually a scheduling person within the firm who assigns auditors to jobs. The audit managers talk to these schedulers all the time, to see who they can get on their jobs. If you understand auditing and you’re efficient, then word gets around pretty fast, and all the managers will want you to work for them. But if you’re not, then that information gets around just as fast, and you’ll find that you’re not being scheduled on jobs anywhere near as much. In essence, you’re the last kid on the playground who gets picked to be on a team. And that means that your billable hours will drop, and you won’t make your annual goal. And if you don’t make the goal, then you’re out.