Billing represents the culmination of the firm's efforts and work product. It is an integral component, rather than a byproduct, of an engagement. Consequently, it requires planning, due professional care, and periodic review. Properly managing the billing process can increase the firm's cash flow and realization on work performed. This article discusses how the firm can maximize its fees effort while reinforcing to the client the value of the services provided.
Billing Methods
A billing method is nothing more than a mechanical means of valuing the professional experience, training, and time of the firm's personnel. Firms use a variety of billing methods, some of which are more sophisticated than others. Regardless of the methods used, however, the firm should remember that billing is more of an art than a science, and no one method is appropriate for all firms or all engagements. With that in mind, the following paragraphs briefly describe various billing methods and the advantages and disadvantages of each.
Fixed Fees Fixed-fee arrangements involve providing specific services for a fixed price. For example, a firm might prepare a Form 1040, including Schedules A, B, and C, for $200, or perform monthly bookkeeping services for $500 per month. The primary advantage of the fixed-fee system is that the firm can accurately forecast income from each client account. In addition, the billing process is streamlined because few details are needed on the billing statements. Disadvantages to fixed-fee arrangements include the following:
- The Fixed-fee System Makes No Allowance for the Complexity of Some Engagements. As a result, a client may feel entitled to any services necessary to complete the engagement at no additional charge, including extensive research or complex calculations. To avoid that hazard, the firm should consider using an engagement letter to explain, in detail, the services provided for the specified fee. If circumstances change or the client asks for additional services, change orders should be used to document the additional services and the change in price.
- The Professional Staff May Have Little Incentive to Incur Additional Time on the Engagement Once Budgeted Time Has Expired. This may encourage lower-quality work by staff members who are eager to complete the engagement.
In some instances, the disadvantages of fixed-fee arrangements can be overcome by quoting fees in terms of ranges. Doing so provides flexibility in what can be charged, thereby reducing the risk of losses. For instance, instead of quoting a fixed fee of $300 for the preparation of a Form 1040, the firm could quote a range of $250 to $400. The range still allows the client to budget for the expense, but leaves the firm the option of increasing the fee if necessary. In addition, billing an amount less than the high end of the range may help in the firm's collection efforts by reinforcing to the client that it was treated fairly.
Form-based Fees Fees for tax services, including the preparation of income, payroll, property, and franchise tax returns, are sometimes based on the number and type of forms prepared. Each type of form is assigned a fee. For example, a simple form such as a Schedule B might be billed out at $50, while a Form 8582, which is more complex, might be billed out at $150. Form-based fees can be advantageous when there are only a few transactions on each form. In addition, the advent of computers has made this method even more advantageous because of the speed with which even the most complicated forms can be processed. Clients can be told in advance what their return will cost, which makes it easier to collect the fee at the end of the engagement or, perhaps, to ask for a retainer up front. The final bill can easily be prepared and delivered with the return.
The disadvantage of form-based fees is that the fee does not take into account the number of transactions on a form. That means that the firm ends up charging the same fee for completing a form regardless of whether it contains one or twenty transactions. Consequently, some firms base the fee for preparing certain forms, such as Schedules D and E, on the number of properties or transactions. Alternatively, some firms calculate fees using both the time-based and form-based methods, and then bill the higher of the two.
Time-based Method Traditionally, the most widely used billing method has been the time-based method. (Although still predominant, it may not always be the most attractive billing method.) Time-based billing requires a comprehensive effort to accurately record each staff member's billable time. Time-based billing consists of the following methods:
- Standard Hourly Rate Method. The standard hourly rate method involves assigning a billing rate to each staff member. Normally, the rate is computed by using a multiple of the staff member's hourly pay. Each person working on an engagement records his or her time and the time is totaled and multiplied by the respective hourly rates to obtain the fee. Ideally, the assigned billing rates reflect each staff member's level of experience and technical competence.
- Variable Hourly Rate Method. A variation of the time-based method is to adjust each staff member's hourly rate based on the type of engagement. The purpose of varying rates is to recognize that complex engagements, such as those involving tax planning and IRS representation, require a person with a higher level of expertise than that required by lower-level services such as entry level bookkeeping services. Consequently, more complex or specialized engagements should command a higher price. Using higher rates for such engagements can help to increase the firm's fee realization.
Firms have used time-based billing because it was generally considered to be a fair and impartial way to value services rendered. In addition, most firms felt comfortable using time to price services because of a popular perception that the product they are selling is time. In reality, however, what is being sold is the experience and ability of a firm's personnel, which does not always translate well using a "rate × hours" formula.
The main disadvantage of time-based billing is that it ignores the perceived value received by the client for services rendered. By correlating fees with time spent, firms may unknowingly bill less for their services than what clients perceive they are worth and are willing to pay. Another disadvantage of time-based billing relates to the time and effort necessary to accurately input, accumulate, and process billable time. Also, since staff members with the same billing rate often work at completely different speeds, some clients, in effect, end up paying for the inefficiencies of a staff member. Clients may negatively perceive that they assume all the risk for increased hours, including inefficiency, on an engagement, resulting in potential collection problems later.
Determining Fees
Regardless of the billing method used, firms should ensure that their fees adequately cover all of their costs and contribute to firm profits. In many instances, marginal profits are blamed on competition or the economy when, in reality, they are the result of inadequate fee setting. In addition, firms should always keep in mind that pricing is more than just a mechanical process. Rather, pricing is affected by various subjective elements such as perceived value. Many firms have learned that when they focus on providing high quality service, clients will pay for that quality. In fact, failing to provide good service is one of the leading causes of client defection. Only rarely will a satisfied client leave due to price increases. Additionally, one of the best ways to insure profitability is to operate the firm using a lower-volume, higher-priced mentality, consistently providing quality service and meeting your clients' expectations. The following paragraphs discuss other factors to consider when setting fees.
Establishing Billing Rates The most widely used method of billing was the time-based method in which each staff member, manager, and partner is assigned a billing rate. Typically, under the time-based method billing rates are determined by multiplying a partner's or employee's hourly pay by a multiple, such as three or four. The purpose of the multiple is to establish a rate that will recover the employee's salary and benefits as well as cover the firm's administrative expenses and allow the firm to also make a profit. When billing rates are computed in this manner, the firm should consider the following:
- Hourly pay, which is determined by dividing the staff member's annual salary by the hours worked during the year, is computed differently in each firm. Some firms only include base salary in the annual salary amount while other firms include bonuses. In addition, firms use a variety of methods to determine the total hours worked during the year. Some firms base total annual hours on 35–40 hour work weeks while others base it on 40 hour work weeks plus estimated overtime. Still other firms base total annual hours on the chargeable hours they expect their staff members to work during the year.
- Choosing the multiple is influenced by many factors including competition, the firm's reputation, size of the firm, and type of service. Local firms generally use a multiple of three to four. Some of the large national accounting firms use multiples of up to six and seven.
Setting Minimum Fees Some firms use minimum fees for each engagement to inform clients of billing policies and to divert lower-fee clients to other firms. For example, a client with an uncomplicated Form 1040 might be informed that the minimum fee for the return is $200. If the client is unwilling to pay that fee, the firm can refer the client to a firm with a lower fee structure. If minimum fees are quoted, the firm should make sure that the client understands that the fee is only a minimum and does not otherwise affect the amount that will be billed.
Considering Competitors' Fees An important consideration for setting prices in any business is what the competition charges. Therefore, it is important that the firm consider the fees of competing firms when establishing its fee structure. When analyzing a competitor's fees, the firm should keep in mind that differences between firms can justify some diversity in fees. Factors to consider include the following:
- Advanced degrees, experience, and training of staff members.
- Specialized expertise of staff members.
- Reputation of the firm and the number of years in business.
- Quality of service.
The firm should be able to justify its fees if they are higher than its competitors'. Otherwise, the firm will undoubtedly lose clients to lower-priced competitors. |
