This article is an extract from the book 'Everything you need to know about Xero Practice Manager'
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Revenue stream breakdown
Revenue streams describe a family of similar services delivered within your practice. Examples might include compliance services, advisory services or bookkeeping services. Within each of these there are a range of services we deliver. Compliance services might include annual accounts, tax returns, and any other services your clients are statutorily required to perform. We have defined some of these revenue streams in Chapter 3: Revenue Streams.
By measuring our revenue streams based on where our time is spent and where our revenues are earned, we can improve the profitability of our practice. This section will cover how to measure and interpret your compliance vs advisory revenues, how to measure and interpret their margins, and how to drill into each of these so you can see what your most and least profitable services are.
One of the challenges in measuring the performance of compliance vs advisory services in your practice is that every client and every client engagement is different. Some of your clients may only use a small portion of the services you could provide them. Others may already use a wide range of your services. Many clients are likely to have a mix of compliance, advisory and other services on the same annual engagement invoiced on a fixed monthly fee. This can make it difficult to determine which services are contributing most to our revenue and profitability and to plan for our future.
So how can we measure the performance of our revenue streams using XPM and Xero?
Job categories allow us to direct revenue from specific jobs to specific income and/or tracking categories within Xero. If you’ve set up your job categories as described in Chapter 4: Practice Settings then you are already well placed to group your engagements by revenue stream and direct these to the appropriate Xero income accounts.
By mapping your general billable job categories to income accounts, you will be able to easily view your income by revenue stream in your Xero. Your fixed-price agreements are invoiced using Xero’s repeating invoices, where you can allocate the appropriate income account to each line item of the invoice. XPM job categories and Xero repeating invoices work together to allow you to view revenue by revenue stream inside your Xero profit and loss each month.
By analysing the relationship between our revenue streams, we can accurately determine what percentage of our revenue is made up of advisory services and what percentage is contributed by compliance services. But as we all know, revenue is not profitability.
XPM job categories and Xero repeating invoices can together tell us where our revenue is coming from, but we’re unable to see the margins on these. Xero knows what our total wages and salary expense might be, but not what jobs have been worked on, or how this time has been spent. XPM knows where our time has been spent and what the cost of that time is, but not how the revenue has been split.
Link Reporting makes it easy for you to see which revenue streams are most or least profitable. It allows us to group our tasks independently of the nature of the engagement, so that we can easily see our revenue and profitability for each revenue stream.
To view your income by revenue stream for a specific period inside Link Reporting, go to ‘Practice > Service Profitability’ and quick-select your date range. This will show you how much revenue, time, cost and profitability compliance services contributed to your practice vs advisory services, providing a margin percentage and average hourly rate for each.
Now that you understand where your time, revenue and profitability come from in your practice, you can start to influence where your future revenue and profits are coming from. But how? And where? To get the detail you require to act on this information, you need the next layer down – service profitability.
Because of the mix of compliance and advisory services on each client engagement, and the various methods of invoicing for these engagements, it is not possible to view which services are most and least profitable to your practice using XPM or Xero alone. Knowing where your revenue and profitability is coming from won’t help you change where it comes from in the future without knowing which services contribute to this revenue. Compliance services, for example, may currently represent 80% of your practice revenue but only contribute 60% of the profits. Advisory services may only make up 20% of your revenue but 40% of your profits. But which compliance services aren’t delivering profitability? Which advisory services are the most profitable to us? To answer these questions and take the necessary actions, we’re going to need to dig a bit deeper.
The Service Profitability report inside Link Reporting allows you to view the services inside your practice that are performing well and those which are not. You can expand out the revenue stream groupings to see which services your team spent their time on, the revenue generated, the write‑ons/offs and profitability of each task so you can prioritise the work that occurs within your practice.
You may find some services within your practice that are unprofitable. There may be others that are not as profitable as they could be. It doesn’t mean we should stop offering these services as they may be required in order to perform higher-value work for your clients. It helps though to understand which services are profitable to your practice. For unprofitable services, we need to know why they are not so we can minimise the time required in delivering them.
Let’s look at an example:
Aaron from Aardvark & Aardvark CA is a 20-staff accounting practice run by partners Aaron and Anne. They’ve grown their practice through close relationships with their clients built on delivering quality tax and regulatory compliance services for their 800 customers. 400 of these customers are individual tax returns with the remaining 400 being made up of annual and monthly compliance engagements. 320 of these customers are on time-charge engagements with a mix of estimated values and hourly rates. The remaining 80 are on monthly fixed-price agreements.
Because they use XPM and Xero, Aaron and Anne can easily see that 90% of their revenue comes from compliance services and 10% of their revenue comes from consulting services delivered by Aaron and Anne. Aaron and Anne have noticed that the increased frequency and complexity of reporting requirements have caused jobs to take longer than they used to. They have recently hired a new team member to pick up the jobs their existing team was struggling to complete on time, along with some of the new clients they have recently brought onboard. Despite seeing an increase in revenue, their profit margin has remained the same, if not slightly decreased, in their practice.
Perplexed, Anne decides to dig deeper. She runs a Service Profitability report inside Link Reporting. She can now see what is really happening. Despite contributing 90% of the revenue, compliance services only contribute 70% of the profit. The remaining 30% is made up of higher-value advisory services they deliver to a small portion of their clients. Diving even deeper, Anne can see the specific tax return types that once generated 80% margin are now below 50% margin because they are taking longer to prepare. Anne can now have quality conversations with her team about why these specific services are taking longer to deliver and can either improve the processes and training or increase their pricing.
Concerned about this growing trend in compliance requirements, Aaron decides to diversify the services they offer their clients by developing training programs for his team and mentoring them to start to deliver higher-value advisory services to their clients. The clients of Aardvark & Aardvark CA are grateful for the advice they were not previously receiving beyond the compliance services they are used to.
As we can see in the above example, it’s only by diving deeper into services that make up your revenue streams that you can start to take informed actions around the services you offer, the processes and technologies you use, and the price you put on those services. Analysing your task-level performance in your practice will also identify training opportunities for your team. You can help your team succeed by providing them the information they need at www.linkreporting.com
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