Perception vs. Reality: The hidden costs to run your practice

0
98

Small practices forget to run a burden rate to calculate their costs of doing business. We either think we are too small and we have a handle on costs and cash flow, or we just do not make it a priority. Without cost analysis, it is nearly impossible to know if our projects are profitable.

Even in a tax organization where our pricing is all value-based and not based on the billable hour, time budgets and burden rates are known. The burden is calculated typically by taking an individual employee’s salary, including payroll taxes and benefits costs paid by the company, and breaking it down into an hourly cost.

General and administrative expenses for things like software, travel, professional development, office expenses, etc., are then all allocated out as a “burden rate” added to each employee’s salary rate.

So, Johnny, for example, might cost $75/hour to have on the team once we factor in the true overhead cost to have him employed and working on projects. Once our foundational cost accounting skills have been kicked in, we can start to understand if our projects are really making money.

INSTEAD OF FLYING BLIND, UNDERSTANDING OUR COSTS ALLOWS US TO PRICE FROM THE OPPOSITE DIRECTION.

Having analyzed many practices from an internal state, I can tell you that the average cost per hour, for even an inexperienced tax staff member, is well over $60/hour. Taking that into account, if you are only billing your clients $300-$400 for Form 1040 preparation, it is unlikely you have any profit margin.

If Johnny, your three-year tenured prep person at $75/hour can prep the client and workpapers in two hours, you have less than an hour for review and admin time just to break even on that return before it goes out the door. That’s a slim margin of error and we all know that most returns take longer than we expect them to.

Johnny probably has to go back and forth with the client at least two to three times before he even has all the information, he needs to prepare the return, and at that point, he already has billed an hour and a half to this project.

Instead of flying blind, understanding our costs allows us to price from the opposite direction. Instead, we are able to have a more informed understanding of what it actually takes to complete a project, then we can add our desired profit margin before quoting the client.

Gut checks and leaving it “up to the market” almost will assuredly leave us in the red.

To help make sure you have not forgotten anything, here are five costs of running a small business that often get overlooked:

  1. Licenses & dues — If you have even a small team of CPAs this can add up. Don’t forget to account for license renewals, state society dues and AICPA dues when calculating overhead costs.
  2. Rent & utilities — Yup, just like a manufacturing client would build this into the costs of their widgets, you need to build this into your per-employee burden rate.
  3. Insurance — You may have remembered employee-specific insurance when you built-in benefits, but don’t forget to allocate overhead costs like liability and cyber insurances.
  4. Credit card processing fees — This one gets missed a lot. We build our revenue and cash flow budgets based on gross prices quoted on engagement letters, but if your clients aren’t paying with cash, your gross revenue is not what you’re taking home.
  5. The cost of collections — We all hope we never have to deal with this, but it happens to the best of us. There is often time and money involved in collecting past due balances, make sure you build it into your overhead rates because it will happen.