Does the rule of thirds still apply now?

Should fees be one third wages, one third overheads, one third profit?

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When I started, it was very much considered that a successful accountancy firm should have accounts that followed the rule of thirds.

One third of turnover covered production staff wages

One third of turnover covered overheads, including non-production staff

The remaining third was the profit for partners.

Was this ever true in the first place? If it was, does it still apply today or has the split shifted? I'm reviewing client fees to ensure they are competitive, and negotiating costs down or seeking alternatives wherever I can, but it would be useful to have a benchmark to compare to.

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By zebaa
05th Aug 2022 08:57

I would say no. This because wages is to overheads as bread is to food – its just a more defined item. My belief is that you should increase your fee each year, even is only a small amount, plus an inflation matching increase. Given the economic forecast, beware of inflation, it is very easy to effectivly cut your income in real terms, for fear of loosing custom or clients.

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By tom123
05th Aug 2022 09:07

Little and often has always been my approach to pricing. Granted, not in practice, but clients never remember that you 'didn't' put prices up - so you never get any goodwill. And you never catch up.

A lot of people may kid themselves they were pricing like that - but, in fact, was there a write off somewhere further down the page, like non productive time etc?

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By Mr_awol
05th Aug 2022 13:24

tom123 wrote:

A lot of people may kid themselves they were pricing like that - but, in fact, was there a write off somewhere further down the page, like non productive time etc?

The old 'we are putting charge rates up' followed by 'why is chargeable time so low' routine. We looked at that as a potential reason to join the 'scrap timesheets' model but i think the (much) better way is to keep the information that timesheets provide, and use them as an analytical tool instead of thinking you can just increase c/o rate and bring in c/t targets and expect profits to soar.

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By Mr_awol
05th Aug 2022 13:21

It depends on your model. There is generally less 'junior' work around - summarising, analysing, etc. TBH we have tried to avoid the lowest level trainee, and generally focussed on paying decent wages to decent/experienced staff. That is a model that i imagine more practices will be joining us in, as the clients move to computerised systems.

That could, of course, result in there being fewer juniors in the pipeline, and that as the 2-5 years' experienced staff filter through they will be lower quality with higher salary aspirations. To an extent the (local) market seems to be showing the early signs of that.

Anyway, back to the question. As you replace 'grunt work' with software costs, and your staff get more expensive, you may start to find where the true efficiencies lie. The software houses want you to see their product as an overhead - but if it is really saving chargeable (human) time - i.e. wage costs, then really it should be in the COS/wages 'third'. That third is already taking a pounding from higher salaries, albeit that hopefully time taken per job is lower. Perhaps those that abandoned timesheets might now find them useful in working out what staff are spending time on - particularly as those staff become more expensive.

Personally i was never convinced on the third/third/third model. It tended to be used to supress salary expectations or justify theoretical charge rates and therefore only really ever served as a stick with which to beat staff. I still believe timesheets, charge rates and suchlike have an important place but never did believe that you can look at profit, adjust a charge rate to compensate for any shortfall in your expectations, and expect the staff and clients to just make it work. One of them will eventually tell you where to go.

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By stepurhan
05th Aug 2022 14:08

Thanks for taking the time to go into so much detail.

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By Mark Lee
05th Aug 2022 15:50

By the time I had my last role in practice a different equation was more common: Starting with gross salary cost (incl Ers NIC), divided by a target number of hours to be worked. = Gross salary cost per hour (worked)
Then double that to get a reasonable charge out rate to cover related overheads, a contribution to general overheads and some profit for the partners/owners

The old model was explained slightly differently to me:
Instead of doubling, you trebled the the hourly salary cost to get target hourly charge-out rate. The other two thirds were intended to cover overheads (1/3) and profit (1/3)

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By Michael Davies
08th Aug 2022 10:02

The one third rule was never realistic.In my last year with the big boys,I was generating £300k of fees.Neither my salary (inc Ni) or overhead was anything like £100k each.I suspected I was generating one partners profit.I never ever resented this;given the amount of c**p a partner had to endure.

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Stepurhan
By stepurhan
08th Aug 2022 15:01

Thanks for the responses all. Much appreciated.

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By mkowl
09th Aug 2022 09:50

I think in the days when you had more staff that were not direct fee earners it was the pricing method. Does anyone still have pure admin staff anymore, it is a shock to my system if I have to do a letter these days, even where we do eg sending self assessment tax returns it is 90% a template letter that I edit for the specifics. The counter factor is the price of software, PI insurance which has gone up I would say above wage inflation

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By Mr_awol
09th Aug 2022 19:49

Is PI really a major cost for anyone?

Hopefully our insurers aren’t reading this but there are many overheads I resent more than that one

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By 123Sheets
09th Aug 2022 15:20

Again, it depends on the accountancy firm model you have.

When I ran my accountancy firm just a couple of years ago, I stuck with the traditional model of pricing and timesheets; with calculated charge-out rates to get my 1/3 profit share; using other KPIs of WIP and Debtors and so forth on a client-by-client basis. We used tech in a discerning way to keep "partner" profit share up as wages went up. I say discerning, as for example we used Excel for most of the in-house bookkeeping rather than use what we found to be slower online and desktop software (even after accounting for OCR software, bank feeds and the like - though I hadn't tested these since 2016). This allowed us to charge £59 per hour + for the bookkeeping, though of course we didn't explain it in those terms to clients, but gave them a fee based on the work involved, which was similar to what the market rate was. That was our lowest charge-out rate in the whole firm back then. Write-offs were significantly lower than Write-ons, as we did get rid of clients that caused write-offs, if they wouldn't take a fee increase. Of course we had to pick and choose which clients this worked with, and we did have significant client numbers (perhaps 50% by fee level) on proprietary software, but we didn't get involved in their bookkeeping ourselves in those circumstances (except advising), as it was not profitable. That said, bookkeeping took up only about 25% of the chargeable work we did perhaps.

For year-end software, its got to be fast software, if it hangs or calculates for too long, its wasting precious time. We chose software on how quickly it got the job done compared to others in tests. The price of the software is almost insignificant compared to how quickly it does the job, as wages are always going to be higher than software costs. So cost of the software was far down the list on choosing software.

My "profit share" as a sole trader worked out at 36% of turnover, after I put through a salary for myself, if I had to employ someone to do my job. We had a small office with 4 staff, including myself.

As software makes the job so much faster than 30 years ago+ (where the 33/33/33 comes from) I found that the admin costs were down, but wages costs had gone up by the same amount as competitive salaries get higher (as its harder and harder to find good staff) and government mandated NI and pension costs went up. Staff costs being 45% and overheads being 19% in my firm. So wages costs were close to 50%, which agrees with someone else above.

Being small, we were lucky to pay no business rates on our office, which helps keep the admin fees down, and all staff worked in a single large room (pre-COVID times, ah!). However, although larger firms might be paying business rates, I am sure the larger firms who also use a traditional model too can generally charge much more than a smaller firm for the same work, as they are seen as a safer pair of hands, particularly for bigger clients and so can utilise higher charge-out rates. So I imagine for larger firms, they get 1/3 profit share for partners too, possibly more. I would imagine in the top 4, its more like 50% per partner, with the hourly rates they can demand.

If "so-called" advisors to accountants want old-school accountants to move away from timesheets, they'd have to come up with ways to monitor fees and costs on a client-by-client basis as good as timesheets do. If they did do that, firms would all change, as no-one likes timesheets, but it serves a purpose for which no-one yet has come up with a better replacement.

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By indomitable
09th Aug 2022 15:13

Personally I always found it a good rule of thumb overall that my direct staff costs were never more than a third of fees, but it varies depending on work type.

Bookkeeping staff costs - used to be around 70% of fees, but have recently outsourced overseas so now it is a third of fees
Compliance staff costs - Third of fees
Tax advice staff costs - varies but overall less than third of fees
Advisory staff costs - Varies between and third and half

If you are growing a practice and want to sell in future it is important that your profit levels make it attractive to the buyer

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