CPA Billable Hours and Productivity Ratio Explained
If your CPA firm generates revenue through billable hours, you need to know more than how many hours your team works. You need to know how many of those hours actually generate revenue and whether your payroll costs are staying in balance with that revenue.
In this Labor Day episode of the Financially Fit Business Podcast, I’m looking at two numbers that can tell you a lot about the productivity of your firm: billable-hour percentage and the productivity ratio, sometimes called the compensation ratio.
These numbers can help you spot problems with staffing, pricing, raises, workload, and profitability before they become bigger issues.
And there’s another question coming quickly for CPA firms: what happens to billable hours when AI can complete work in minutes that once took your team many hours? I’ll tackle that in next week’s episode.
Start With the Hours You’re Actually Billing
For many CPA firms, billable hours are still the primary unit of revenue. The more hours your partners and associates bill, the more revenue the firm generates.
That’s why the first number I want you to look at is simple: how many of the hours you’re paying for are actually billable?
An employee may be salaried based on roughly 40 hours a week, but not every one of those hours can be billed to a client. You have vacations, holidays, required CPE, training, meetings, and other activities that aren’t billable.
I use approximately 91% as a planning benchmark for total available billable time after accounting for those normal nonbillable requirements.
The point isn’t that every employee has to hit exactly the same percentage. The point is that you need to track it.
How many hours are your associates billing? What about your partners? Are there large differences between people doing similar work? Has someone’s billable percentage dropped significantly?
Your answers can lead you to issues you wouldn’t see by looking only at total revenue.
This connects directly to something I’ve discussed before: understanding your true unit of revenue. If billable hours are what generate your revenue, you have to know what each of those hours is producing.
More Billable Hours Aren’t Always Better
There’s another side to this.
Some firms put enormous pressure on team members to bill 50 or even 60 hours a week. Yes, those hours generate revenue. They can also generate burnout.
That’s why productivity isn’t simply about squeezing the maximum number of billable hours out of every person.
You want enough billable activity to support the economics of the firm without creating a work environment your team can’t sustain.
Calculate Your Productivity Ratio
The second number I want you to track is the productivity ratio, which is also sometimes called the compensation ratio.
The calculation is:
Payroll + Payroll Taxes ÷ Revenue = Productivity Ratio
If your ratio is 40%, you’re spending 40 cents of every revenue dollar on payroll and payroll taxes.
If that ratio increases to 60%, you’re now spending 60 cents of every revenue dollar on those costs.
This is where the ratio becomes counterintuitive.
With many financial trends, an increasing number looks positive. Not here.
A rising productivity ratio generally means your payroll costs are consuming a larger percentage of revenue.
A stable or declining ratio is generally the direction you want to see.
I’ve gone deeper into how this trend behaves over time in my episode on understanding productivity ratio trends.
What Should You Include in the Ratio?
For this calculation, I use payroll and payroll taxes.
I generally don’t include bonuses unless they are a normal operating expense tied directly to revenues, such as certain sales compensation.
I also don’t normally include health insurance, workers’ compensation, or other employee benefits in the basic productivity-ratio calculation.
Consistency matters. Once you’ve determined how you’re calculating the ratio, use the same approach each month so you can see whether the trend is changing.
CPA Firms Often Have Higher Compensation Ratios
In my experience, CPA and legal firms generally have higher productivity ratios than businesses that sell products or have significant material costs.
That makes sense.
What are you selling?
Primarily your team’s time, knowledge, and expertise.
For many CPA and professional service firms, I’ve seen compensation ratios above 50% and frequently above 60%.
The specific percentage is less important than knowing what is normal for your firm and watching what happens to that percentage over time.
Find Out Why the Ratio Changed
If your productivity ratio suddenly moves, don’t just note the number. Find out why.
A ratio that moves up and down sharply could reflect seasonality or changes in the mix of work you’re performing.
If it increases after the first of the year, ask whether you gave raises.
Did you hire another employee?
Did you add management or administrative staff?
Did payroll increase without a corresponding increase in your billing rates?
Those are the conversations I want you to have with your clients, too.
If a company increases compensation but leaves its prices unchanged, payroll can consume a larger percentage of revenue and reduce profitability.
Raises May Mean Rates Need to Change Too
Giving raises isn’t the problem. Good employees expect and deserve appropriate compensation.
The problem occurs when you increase payroll without recognizing what that increase does to your cost structure.
For example, if you give employees a 5% raise, your actual cost increase is more than 5% once payroll taxes and other compensation-related costs are considered.
That may mean your rates also need to increase if you want to maintain your existing profitability.
This is why financial ratios are useful. They let you see the impact of decisions instead of simply assuming the business can absorb another expense.
Billable Hours and the Productivity Ratio Work Together
Your billable-hour percentage and productivity ratio don’t operate independently.
If billable hours increase and generate more revenue while payroll remains relatively stable, your productivity ratio should improve.
If you’re paying for the same number of hours but fewer of them are producing revenue, the productivity ratio may move in the wrong direction.
That’s why I want you looking at both numbers.
One tells you how much productive time you’re generating. The other tells you how much of your revenue is being consumed by payroll.
Then AI Changes the Billable-Hour Equation
Here’s where this gets interesting.
I recently had a client use Claude to complete work in about 30 minutes that could previously have taken his team approximately 40 hours.
The client still received the work they needed.
But what happens to the bill?
If you’re charging entirely by the hour, becoming dramatically more efficient can actually reduce what you’re able to charge.
Are clients paying for your time, or are they paying for your expertise and the result you provide?
AI is making that question harder for accounting firms to ignore. I’ve talked previously about how AI is already changing accounting work, including what that shift could mean for billable hours and pricing.
It’s also one reason more firms are examining value-based pricing instead of traditional billable hours.
Know Your Numbers Before You Change the Model
Next week, I’m going to look more closely at what might happen if your firm eliminates billable hours and what that could mean for your clients, your team, and your bottom line.
Before you change anything, know where you are today.
Track your billable-hour percentage. Calculate your productivity ratio. Watch the trends. And when either number moves, find out why.
The number itself gives you information. Understanding why it changed gives you something you can act on.
Help Your Clients See What Their Numbers Are Telling Them
If you’re expanding your financial advisory services, Financially Fit Business can help you turn financial statements into clear trends you can review with your clients and use to identify issues before they become major problems.
See how Financially Fit Business supports financial professionals.
More About Billable Hours and Productivity
What is the productivity ratio in a CPA firm?
The productivity ratio measures payroll and payroll taxes as a percentage of revenue. It helps show how much of every revenue dollar is being used to compensate the team generating and supporting that revenue.
How do you calculate the productivity ratio?
Divide payroll plus payroll taxes by revenue. For example, a 50% productivity ratio means 50 cents of every dollar of revenue is being spent on payroll and payroll taxes.
Is a higher productivity ratio better?
No. This ratio is counterintuitive. A higher percentage means payroll and payroll taxes are consuming a larger percentage of revenue. Generally, you want the ratio to remain stable or decrease, and you should investigate significant changes in either direction.
Why should CPA firms track billable hours?
If billable hours are the firm’s primary source of revenue, tracking them helps show whether the hours being paid for are producing enough revenue to support payroll, overhead, and profitability.
How could AI affect billable hours for CPA firms?
AI can dramatically reduce the time required for some accounting tasks. That creates a challenge for firms that price work strictly by the hour because greater efficiency may result in fewer hours to bill even when the client receives the same or greater value.