Article in Accountancy magazine, November 2004

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This article, discussing the importance of
profitability analysis, first appeared in the
November 2004 issue of Accountancy magazine.

Mungo Dunnett Associates 11 Polstead Road, Oxford
OX2 6TW Tel [phone] Email
info_at_md-as.com Web www.md-as.com We operate
across a range of professional service firms.
Our focus is on ensuring that your activities
are geared towards the areas that are most
commercially valuable.
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Unprofitable activities
Without knowing what is profitable and what is
not, firms are flying blind, warns MUNGO DUNNETT
the hidden cost
Accountancy is the numbers specialism, and yet
its surprising how often accounting firms
demonstrate the same disregard as other less
numerate service businesses for the most telling
figures of all. At the heart of the problem is
the very basic difference between top line income
and bottom line profit. Practically no knowledge
is more valuable to any firm than the ability to
identify which customers are generating the
lions share of their profit. This sounds so
obvious, yet a remarkable number of firms do not
have this key information the information that
drives their bottom line at their fingertips.
The result is an operating model in which costs
are simply not aligned efficiently to profit
generation. Expensive people are tied up with
marginally profitable (or even value-destroying)
work, and the firms activities and resources are
spread too widely across an unstructured raft of
sectors, specialisms and locations. In this
type of scenario, it is no wonder that profits
remain flat while billings increase. And these
are not traits unique to accounting firms many
of the biggest blue-chip companies in the UK are
unable to determine exactly where their profit is
coming from. But the competition within the
accountancy market is sufficiently intense that
you cannot afford to keep steering
strategic and operational decisions without close
information about their actual profit impact
without knowing what is profitable and what is
not, you are flying blind. At the heart of
successful business strategy is an understanding
of your market, and your skills, to allow a close
focus on precisely those activities where you can
function most profitably. What this entails is
two things knowledge and the ability to act
upon this. Knowledge First, knowledge.
Effectively, this entails your ability to
assemble the relevant management information to
inform your decision-making, resource allocation
and priority-setting. While the identification
of profit is so often considered to be some sort
of black art, it is really not that complex, and
certainly not that costly to deliver.   In
order to understand your client profit you
firstly need a robust breakdown of your own staff
costs. This means all the costs that While the
identification of profit is so often
considered to be some sort of black art, it is
really not that complex, and certainly not
that costly to deliver can be reasonably
attributed to the winning of a given client,
support work for the client work, actual
servicing of the client, and any further
in-office or out-of-office expenses entailed.
Suddenly all that busy effort is seen for what it
is a significant cost base,
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In order to analyse the data, you also need a
management information system simply, a
database that enables you to load and examine
multiple entries. This is not simply an in-house
accounting package everybody has one of those,
but it will only give you bottom-line numbers,
without telling you why the numbers are as they
are. The software itself really isnt the key
factor any basic system that allows multiple
entries and an element of analytical examination
will suffice. Microsoft Access, for instance, is
entirely adequate. Into this database needs to
be loaded the client data (what you have billed,
in a single view across the range of your
accounting or advisory services, and the billing
dates) and the cost to serve (which of your staff
have been working on the client, for what time,
and with what other directly attributable costs).
Now you can determine the profitability of
your client work. Again, there is no need to get
bogged down in endless detail all you want is a
workable steer for the firm. But what it will
show you will be absolutely invaluable. Suddenly
you will see that your more demanding clients
actually lose the You can lose profit with
astonishing speed through apparently minor
customer attrition or fee reductions firm
money that a great swathe of middle-ranking
clients make you very little at all and that a
small number of star accounts are propping up
the profitability of the whole firm. In other
words, your client profit will be showing a
fairly typical Pareto (or 80/20) skew.
taking up considerable time for some of the more
expensive staff members on the payroll.
  Determining staff costs correctly Each staff
member needs to have a cost per hour fully
loaded calculated. More controversially (and
yet if you dont do it, you wont have any decent
information) you need to install a timesheet
mechanism and make sure people use it. I often
hear complaints about this staff There is no
need to get bogged down in endless detail all
you want is a workable steer for the firm
will be up in arms, nobody will bother filling
it in, and theyll all cheat on their timings. I
have very little sympathy. If this is not how
your firm operates, you are the poorer for it.
Its time to get tough with the staff it will be
done, they will do it properly, and if they dont
or wont its a disciplinary offence. Of
course, this comprises the basics of activity
based costing but it is vital that this
exercise is kept at a relatively high level.
Costing exercises can descend into depths of
analytical minutiae that are utterly unnecessary
for you something that is adequately robust is
all that you need in order to stop the circular
debates, and start generating the big wins.
After all, there is little value in arguing
indefinitely over the fine detail of cost
allocations when the firm continues to spread its
servicing and business development efforts across
all clients profitable and unprofitable
alike.
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own profit every time you give in to their
demands. And the same thing applies to your
business development activities if you do not
know which types of customer (or sector, or
service) are the ones that are vital to your
profit, you will not know what to focus your new
business expenditure on.   Implementing the
findings   Although the analytical work is
vital, the critical element and the only
activity that will start to repay your effort in
producing this management information is making
sure you implement the findings. This will mean
establishing a new sense of focus for the entire
practice what you are going to focus your
activities on, and the kind of work you are now
going to set out to win. Without
implementation without changing the way you
currently do all of these things you will
simply not manage to take your business
performance to the next level of efficiency. And
this, in any business, is the hardest step of
all making the changes that you know in your
heart are necessary.
The applications of Pareto that 80 of anything
is typically generated by 20 of the active
agents will in fact go further than that. They
will be visible all over your firms activities.
See The Pareto Effect The top 10 of your
clients will be generating a huge proportion of
your overall profit. The middle 50 or 60 will
be doing remarkably little for you apart from
absorbing 50-60 of your total costs, of course
and the bottom 10 are probably costing you a lot
of money to service.   If you are not able to
identify those customers or sectors, or
geographies which prop up your entire business,
and make absolutely certain you are looking after
them properly, you can lose profit with
astonishing speed through apparently minor
customer attrition or fee reductions. By the
same token, if you are continuing to capitulate
to customers who may appear important, but who
are actually making you nothing or even losing
you money, you are destroying more of your