The timing for owning and operating a Professional Services firm is now - it always is. A 2017 Australian Financial Review article reasoned that Australia was fast-becoming a Professional Services nation - with the sector reflecting the greater business sentiment found across a broad range of industries.
Professional Services Firms Profit Splits
Some important changes have occurred over the last 12 months for the industry. We have written previously on this, so I will not go into too much detail in this article, but the Professional Services Firm Partner profit split - is an area under increased scrutiny from the Australian Tax Office (ATO).
The ATO has released parameters that advise on low, medium, and high-risk areas of compliance, and if you fall within the medium or high-risk categories, then you will potentially be having some discussion with the ATO.
If you wish to stay in the 'low risk' area for audit purposes, then the main parameters result in:
- Individual Partner profit split of at least 50%
- Total effective tax rate greater than 30%
Of course, there are many combinations of profit-splitting and tax rates to play with - the 'low-risk' number must be less than or equal to seven.
Reimbursement Agreements - S100A
Although our Professional Service firms may operate through a Company structure, Partnership or Unit Trust - somewhere within our own personal entity structures lies the Discretionary Trust.
This is the Trust that receives the income that is directed to various family beneficiaries and other entities. The updated S100A legislation is targeting the distributions from this Discretionary Trust to lower taxed individuals and entities, by making sure that the actual profit is firstly declared as income by the beneficiary and then making sure that the beneficiary has received the monies that the Trustee made them entitled to.
With any piece of legislation there are carve outs and once again the ATO has provided parameters and examples as to what constitutes 'Low Risk' activity in this area.
So, not only do we have to measure our profit splits, but once that has been satisfied, we need to make sure that any further income splitting is satisfying the "receiving of monies" rule.
Business Issues
There has been plenty of media coverage recently on four-day work week trials for a better work/life balance. It is early in the process, so we wait to see the outcomes and commentary as these trials progress.
The leverage of Partners/Directors to team members in a Professional Services firm seems to be adjusting. Some are going smaller, down to 1:5 instead of 1:8 as in the past. Some efficiencies were allowing 1:10. Is this a result of a skill shortage? Have Professional Services firms adapted to these leverage adjustments by employing more support staff for lower-level work or in fact "outsourcing" some operational work so that the "in-house" leverage that is seen by team members and clients alike are optical only?
Certainly, the use of technology has allowed the Professional Services firm to do more with less. The transition to a tech-heavy environment is just beginning, so the jury may still be out on where the final leverage ratio will land.
Just as the above adjustments impact the office space requirement for Professional Services firms, what will the new office layout look like? A hub and spoke style arrangement has been raised again instead of using the pure open-plan office space. Team members and Directors need quiet space to meet or perform intense thought-work. What will be the new square-metre per team member? The answer to this is beyond the scope of this article, but it is certainly a hot topic amongst the clients we talk with, which includes property agents and developers.
Another topic we come across regularly, and probably a little more lately due to the rise of input costs to the business, is the "charge-out rate" discussion. Most Professional Services firms 'charge-out' either as an hourly rate or on a "value-based" metric. There are other revenue models for various Professional Services firms like project revenue, asset management fees, etc.
The discussion is how to maintain margins. As owners, we are paying more for team members, occupancy costs, software/hardware, even the networking coffee and food is going up in price. To maintain margins, the price we charge our clients must also increase. Businesses must still prove value when raising prices for clients, but for a Professional Services firm to continue to invest in the business and provide real value for clients, it must generate positive cash-flow.
Making sure that there is real time data available to Professional Service firm owners that measure this margin metric (each Professional Services industry seems to have their own metric for this exercise) is extremely important. Managing the cash-flow - from reviewing Work in Progress (WIP) and debtors and pricing agreements - is an important task for the Professional Services owner. A Professional Services firm is traditionally capex light and labour heavy - so if you're relying on time-based billing for your revenue, cash-flow must be front of mind. Also, how to find more hours in a day!!
There is commentary in the media currently, around the service sector inflation becoming embedded just as the goods sector inflation moderates and falls. Inflation is becoming political, so we need to be careful as Professional Services owners not to stoke the fire too much. The Interest Rate rises have not stopped yet, so the impact of discretionary spending and mortgage repayments for clients and team members has become a regular topic for conversation around the office as well.
I know I hype on to clients and other Professional Services owners about debtors, but debtors need to be tightly managed. Having the conversation early with clients about payment terms, repayment schedules or other financing alternatives is both proactive and a necessity. Debtors on a Balance Sheet may be recorded as a current asset, but a debtor balance cannot pay staff, rent or the mortgage. Debtors are not an ideal asset nor a long-term asset of a business. Debtors need to be converted to cash as soon as possible.
I wrote last year on the trade-off between being busy and profitable work. Taking on additional clients, or ramping up production for products for little margin, or in some cases, no margin just to win a job or reach a KPI for new client introductions makes no sense. Another year on and it is still happening. Everyone will have their own reasons for this, but one of the most valuable resources an individual working/owning in a Professional Services environment has is time. Do not waste it - you only live once.
For More Information
As always, for any further information on what I've discussed above, the team at Archer Gowland Redshaw are here to assist. Please feel free to contact our office on (07) 3002 2699 | info@agredshaw.com.au.
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