Deciding If A Merger Is Right For The Firm.

• Author: Mastracchio, Nicholas J.

Today, there are many reasons for a CPA firm to seriously consider pursuing a merger as a growth strategy. Consolidators are acquiring CPA firms and the profession is developing additional services for firms to offer. Often, these additional services are also offered by non-CPAs. Although colleges and universities are in the transition phase of converting their auditing courses into courses on auditing, attestation, and assurance services, not many CPAs can claim an academic background in these new services.

The future of CPA firms may be to either grow into a broader more diversified firm or become a boutique firm specializing in a small area of practice. Either way, the firm should plan its direction and focus on where it is going. If the firm decides to expand its scope of practice, mergers and acquisitions may be an excellent device for acquiring the expertise and client base to provide the services. However, the planning for where the firm is going should precede the mergers and acquisitions. A review of the fundamentals that the firm should cover when contemplating its future follows.

The firm's current characteristics

Firm owners need to understand where the firm is today to plan for the future. To do this, owners should have a number of statistics on hand-specifically, concerning services, staffing, profitability, and the factors contributing to profitability. Some of these may be readily available to the firm from its time and billing system, whereas others may not be and will require a little digging.

Services. The firm should categorize its fee generation by the categories of work it performs. The standard categories of audit, tax, accounting, and management advisory services come to mind. However, firms should be more specific. Firms with a large audit practice may wish to identify audits for school districts, governments, health care, not for profits, or other significant client groups. Taxes may be broken down into compliance and consulting or personal and corporate. Management advisory services should be classified into areas where the firm has a niche or wants to develop one, such as pension support, financial planning, litigation support, valuation, computer consulting, and systems analysis.

Staffing. The firm should express its staffing by category and in terms of full-time equivalents (FTEs). The categories should include, at a minimum, owners, professional staff, and support staff. Many firms may want to break these categories down further or add paraprofessional or other categories. Each staff member is either a full-time person or some "portion" of a person. If the firm has specific expectations for the hours a particular category of person should produce in a year, this number can be used to determine FTEs. If the firm does not have such a specific expectation (but it should), the average number of hours for staff in a particular category can be used.

Once a firm's FTE is identified, it should measure its leverage and utilization.

Leverage is the ratio of staff to owners. It is an indication of the effectiveness of the owners in managing staff. Two common leverage indicators are total employees leverage (overall firm FTEs/owners) and professional staff leverage (professional staff FTEs/owners). Utilization measures the productivity of the staff. This can be expressed in total chargeable hours per FTE, per category, and as a percentage of the total hours worked.

It is also worthwhile to track the nonchargeable hours by categories. Examples are professional development, practice development, and promotion, along with holidays, vacation, sick time, personal time, and general office time.

Profitability. Profitability can be expressed in two ways. The most common is the profit per owner before any owner compensation. The other requires dividing owner compensation into two component parts: fair compensation and the return on their investment in the firm, and then adding fair compensation to expenses. This provides a better picture of actual operating profits of the firm and eliminates distortions in comparing firms that have a high concentration of owners with those that have a low concentration of owners. The challenge with this method is identifying fair compensation. Some firms may have a comprehensive compensation formula for owners that identifies hours worked, new business brought to the firm...