Knowing how to value a CPA firm isn’t easy since a lot of factors impact the firm’s value. Have you ever asked yourself how best to price your accounting practice? Many organizations have a hard time determining the value of their own company.

In this blog, I’ll highlight the factors you have to consider when estimating the actual value of your CPA firm. Or that of another person if you are the buyer. We’ll also understand the most important and relevant methods used by business valuation firms to calculate a CPA firm’s value. By the end of it, you’ll have a clearer idea of just how to assess your firm’s worth.

Valuation Methods to Understand How to Value a CPA Firm

Multiple of Gross Revenue

Here, we multiply the firm’s total sales for the last year by a particular figure. Typically, this number is equal to 1; however, it can be more or less depending on a firm’s reputation, its clients, and the opportunities for its development. For instance, if a CPA firm’s revenue was $500000 in the past year and the multiple is 1, the firm’s value is $500000.

Net Cash Flow Multiple

This method focuses on the net cash flow, which is the amount of cash a firm has after all other expenses have been incurred. This net cash flow you then multiply by a figure that is representative of the market value. This gives you a general feel of how much the firm is worth. For example, if a firm has a net cash flow of $200,000 and the multiple is 5 then the firm will be valued at $1,000,000. This method enables one to compare the financial position and performance of various firms within a short span of time.

Market Approach

The market approach involves the use of actual sales of similar companies in the determination of value. It is similar to knowing what other CPA firms have offered and then basing prices on that. Some of the considerations are the size of the firm, location, range of services offered, and financial performance. For instance, if there is another similar firm in the same region with similar revenues and services offered and the firm is sold for $600,000, it is easier to determine the value of your firm. This method uses real data but needs a sufficient number of similar sales transactions to be useful.

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Asset-Based Approach

This method appraises a firm based on the total value of its assets less its liabilities. Examples of assets are office furniture, buildings, machinery, patents, or other kinds of trademarks. Liabilities are things such as loans or accounts payable. For instance, if a firm has total assets of $300,000 and total liabilities of $50,000, then the firm is worth $250,000. This approach is simple and based on historical data, but it can be ineffective for estimating the value of intangible assets or the firm’s future earnings.

Cost Approach

The cost approach of valuing a firm involves estimating the cost of replacing the existing tangible and intangible assets of the firm and then deducing any depreciation or obsolescence. This includes physical assets such as computers and office furniture as well as non-physical assets such as client lists. For example, it may take $400,000 to replace all the firm’s assets. And if these assets have depreciated by $100,000, the value of the firm would be $300,000. This method gives an objective value but may not reflect the value of the firm’s ongoing operations or growth prospects.

5 Variables That Collectively Help Bring Up a Value

When understanding how to value a CPA firm, most people focus on wanting to know just one thing—what is the multiple?

Everybody is so laser-focused on this because accounting firms are traditionally sold on multiples of gross billing. However, it should be noted that the multiple is more like an effect. We, as professionals, need to focus on the cause. So, let us understand five variables that work together and collectively bring up value for a CPA firm.

Cash Upfront

The amount of cash paid upfront is a crucial variable in valuing an accounting firm. Typically, deals involve a nominal upfront payment, ranging from zero to twenty percent, with many transactions actually leaning towards the lower end or even zero percent. The timing of the deal significantly influences this percentage. For instance, if an acquisition occurs right after tax season when most revenues have been collected, the upfront payment will be different than if the deal closes just before tax season. Therefore, while the depth of the buyer’s pockets matters, the context and timing of the acquisition play a pivotal role in determining the cash upfront.

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Retention Period

The retention period refers to the duration during which the changes in client base revenues affect the purchase price. This period can vary significantly. It’s rare not to have a retention period in smaller firm acquisitions. The shortest retention period you might see is one year, but it often extends over several years through structures like earn-out or collection deals. For example, a deal might involve paying 25% of collections over five years. The length and structure of the retention period are critical because they directly influence the perceived stability and profitability of the acquired client base.

Profitability

Profitability is another key variable, but it should be considered from the buyer’s perspective rather than the seller’s. The seller’s profitability can be misleading due to differing operational efficiencies and costs. For instance, a practice run from a home with minimal overhead can appear highly profitable. However, the profitability changes if the practice moves to an office with increased expenses. The real focus should be on the successor firm’s potential profitability post-acquisition. If the buyer can integrate the new practice without significant incremental overheads, the acquisition is more profitable. Conversely, retaining existing staff or locations can decrease profitability, impacting the firm’s value.

Payout Period

The payout period is the time frame over which the buyer pays the seller. For small firms, this period usually spans four to six years, with five years being the most common. The duration of the payout period can affect the overall value significantly. A longer payout period often allows the buyer to manage cash flow more effectively, thereby justifying a higher valuation. Conversely, shorter payout periods may necessitate a lower valuation due to increased financial pressure on the buyer.

The Multiple

Finally, the multiple itself is influenced by the interplay of the first four variables. The multiple represents the effect of the value-driving variables. For instance, a deal with no incremental overhead increases, a long payout period, and minimal upfront cash is highly attractive and can command a higher multiple. Conversely, deals requiring substantial upfront cash, shorter payout periods, and higher retention risks will see lower multiples.

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An Example

Consider an acquisition scenario where the buyer can absorb the seller’s practice with no additional overheads. This scenario is highly profitable. Suppose the buyer offers to pay 19% of collections over ten years with no cash down. This deal would be very appealing due to minimal risk. After five years, even if some clients are lost, the buyer would have already recovered a significant portion of the investment. In contrast, if the seller demands full cash payment upfront, the buyer might value the firm much lower. Maybe around 50 cents on the dollar due to the increased financial risk.

When valuing an accounting firm, it’s crucial to understand that the multiple is the outcome of several interrelated variables. By collectively considering the cash up front, retention period, profitability, and payout period, buyers and sellers can better negotiate a deal that reflects the firm’s true value. A successful transaction isn’t about isolating one variable but packaging all these elements into a cohesive, win-win deal that meets both parties’ financial and strategic goals.

Few Other Factors That Have an Impact on CPA Firm Valuation

Marketing

Marketing plays an important role in bringing in new clients and maintaining the market position of a CPA firm which affects its valuation greatly. Advertising shows the ability of the firm to attract and retain customers, portraying growth prospects to the buyers. These are digital marketing, local advertising, and client referral programs as part of the marketing strategy. Since the current firm has a well-developed website and a history of successfully closing deals, it looks more attractive to potential investors in terms of performance and potential.

Growth Rate

A CPA firm that is growing at a faster rate, like 30% per annum, will have a higher valuation compared to a firm with a lower growth rate. Fast growing shows that the business is expanding, and is well-positioned to meet the market needs and properly managed. Customers and investors are attracted by firms that show greater increases in size, as this is an indicator of future growth and market dominance. High growth rates signal the firm’s capacity to acquire additional clients and generate higher revenues, which makes the firm a better investment prospect than slow or declining firms.

Company Size

CPA firm size has an impact on its valuation because it determines its marketability and the interest that buyers will have in the firm. Larger firms tend to have a higher value due to such factors as the number of clients they serve and their operational capacities. But this can also be advantageous since these are usually the firms with lower overhead costs and may possibly have more prospects for buyers. The key is balance: it means that a firm should be of considerable size to establish stability and growth at the same time but should not be too large to be unappealing to various buyers.

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Company Location

Companies established in urban areas are able to tap into a larger and more diverse customer base and talent, thus increasing their competitiveness. Because of these benefits, properties in urban areas are usually more expensive than those in other areas. However, rural firms can also be useful, especially if they operate with lower cost structures and loyal customers. The impact of location on client acquisition, operational costs, and employee recruitment should therefore be analyze to ascertain a firm’s worth.

Composition of Client Base

Companies that have a large and stable customer base, especially those that offer services to a select few or to a restricted market, are usually valued highly. Firms offering specialized services like consulting or industry-specific services can charge more because of their specialized knowledge and established clientele. The existence of a large number of clients is evidence of stable revenue and further development. Such a firm is more appealing to buyers who seek to align their goals with those of the firm.

Your Team’s Quality

A highly qualified and experienced team of professionals adds credibility to the firm and improves organizational performance. It is important for buyers to acquire firms with competent staff capable of handling client relations after the sale. The proposed idea of training and developing the members of the team increases the quality of service delivery and increases the market value of the firm. A team that is strong and well-coordinated is a major resource that results in client satisfaction and firm revenues.

Conclusion

So this was it. We discussed some important and commonly used business valuation methods to value a CPA firm and learned some critical factors that impact the firm’s valuation. Remember that when selling your firm, it has to be profitable for the buyer to invest what you expect. If not, they’ll either value it much lower or might not buy it. If you’re looking to get your CPA firm valued, feel free to contact our Arrowfish Consulting team.

Our team has a combined experience of 200+ years, with our professionals being Ph. D.s in Economics, MBAs, CFAs, and CPAs. In the past few years, we have appraised many CPA firms and almost every business category, from Fortune 500 to small indie companies. If you need an in-depth business valuation, fill out this small form, and we will contact you soon.

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Jeremiah Grant

Jeremiah Grant is the Managing Partner of Arrowfish Consulting. In addition to acting as a primary liaison for many of the firm’s engagements, He primarily focuses on business valuation and economic damages expert witness assignments, in addition to forensic accounting and insurance claims analysis.

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