4 metrics to calculate your firm's return on investment
Growing your accounting practice requires an investment of time, money and resources. Smart growth happens when you are investing in the areas you know will bring you a return, without wasting effort in areas that do not deliver results.
These four metrics are crucial for calculating your firm's return on investment. Tracking these will help you grow smartly by:
Showing how much you are spending acquiring each client
How quickly you are paying this back
What that client will be worth to you over your entire relationship with them
Cost of client acquisition (CAC)
What is it?
This metric tells you the average amount your firm is spending to acquire a new client. This spend usually refers to any sales and marketing expenses.
Why measure it?
Tracking your CAC measures the profitability of your sales and marketing efforts. Not only is CAC useful on its own, when it is used in conjunction with your Payback Period and LTV it becomes even more powerful.
Looking at it with these other metrics enables you to calculate how much profit you are making from your clients relative to the amount you spend acquiring them.
If you acquire clients through multiple channels (eg. referrals, social media, events), CAC can be used to assess which channels are the most profitable.
CAC in action
Calculate CAC by combining all of your sales and marketing expenses for a period (eg. last quarter, for example) and dividing that by the number of new clients added in the equivalent current period (eg. this quarter).
During the previous quarter, your firm may have spent a total of $4,300 on hosting your website, an external copywriter for your blog, a social media course training for one of your staff members and advertising using Google AdWords. On top of this, $26,000 of staff wages from that quarter can be attributed to sales and marketing activities. In total, your sales and marketing expenses were $30,300.
If you acquire 8 new clients in the current quarter, your CAC would be $3,787.
A key measurement of practice growth and profitability is to look at the costs to acquire customers, including salaries and marketing costs. Spend less and earn more—it’s that simple.
Payback period
What is it?
Payback period is the time, usually in months, that it takes for your firm to break even on your CAC, from revenue.
Why measure it?
This metric tells you whether you are spending too much on acquiring clients, or if you are not attracting the right kind of clients.
If your payback period is longer than you thought it would be—typically, accounting firms should expect around 3-4 months—then you need to think carefully about reducing your sales and marketing costs, or targeting larger prospects who will have greater funds to spend with your firm.
Payback period in action
With CAC of $3,787 and average revenue per client (ARPC) of $1094, your firm’s payback period is 3.45. This would mean that on average, it takes you 3.5 months with a new client to break even on what you spent acquiring them.
Generally, a payback period of 3.45 shows your firm is doing well in this area, but it does indicate that you can afford to invest slightly more in sales and marketing to acquire great new clients, and should explore this option.
Lifetime value of a client (LTV)
What is it?
LTV shows the total financial benefit you can expect from a client over the course of your firm’s entire relationship with them.
Why measure it?
On its own, LTV is a useful estimate of what a client is worth to your firm over the course of their relationship with you. You can segment your clients and assess the LTV of various client types, which will help you to identify your more profitable groups and find out who are the clients you should be aiming to gain more of.
Your findings will become even more useful when you compare your LTV to your CAC.
LTV in action
To calculate your LTV you first need to know how long your clients are staying with your firm. Start with your churn rate and invert that value (1 / Churn rate) to calculate how many months on average your clients stay with you. A 2.8% churn rate works out to 35.7 months.
You will also need to know your Gross Margin percentage (the percentage of profit that remains after your costs have been paid), and your ARPC.
So, with a Gross Margin of 60%, Churn Rate of 2.8%, and ARPC of $1,094, your calculation would look like this, giving you an LTV of $23,433.48.
Only by looking at the LTV can we truly get a deeper view. If the LTV is low and your CAC is high, you could be delivering services for an extended free period or simply not have the fuel in the tank to go and acquire new clients.
LTV:CAC ratio
What is it?
Your LTV:CAC ratio compares a client’s lifetime value to your firm, with your costs to acquire them.
Why measure it?
Comparing LTV with CAC shows you if your practice is spending enough on marketing activities to ensure long-term growth, or if you would be better off reducing the total number of clients you are servicing. It also reinforces the importance of building long, mutually beneficial relationships with your best clients, instead of aiming for smaller, more immediate wins.
Common LTV:CAC ratios in the accounting industry are 4:1 and 5:1, which means practices are earning from clients 4 or 5 times the amount they spent acquiring them. If you are seeing a ratio lower than this, you know you are spending too much.
A higher ratio is not necessarily good either—this can indicate you are spending too little on sales and marketing and could be missing out on valuable business.
LTV:CAC ratio in action
If your firm’s LTV is $22,645.80 and your CAC is $3,787, your LTV:CAC ratio is 5.9:1. While this means your cost to acquire new clients is being outweighed significantly by your clients’ LTV, it highlights that you have a lot of scope to grow and should invest more in client acquisition.
