Inside Audit Firms: A CFO’s View

After 15 years in the business, a finance chief describes how audit firms operate, manage growth, and pay their partners.
David KatzApril 2, 2015

During periods of explosive growth, the role of the CFO of an auditing firm often involves scrambling to help it adjust internally to all that change, Michael Barton recalls.

Now the finance chief of global law firm Goodwin Procter, Barton spent 13 years in finance roles at Grant Thornton, a second-tier accounting firm, and two years as the CFO of Rothstein Kass, a smaller audit firm recently acquired by KPMG. At each outfit, he worked to patch together operations during lengthy growth spurts. “A lot of what happened behind that growth was that things were done on the fly and there weren’t always business processes put in place to handle things,” he says.

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Michael Barton

Michael Barton

When he joined Grant Thornton as a senior project manager in 2000, one of the first things Barton remembers doing was helping to package the firm’s e-business consulting division for sale, eventually to Hitachi. That deal brought GT’s already sinking revenues down further, according to Barton. But in 2002, in the wake of Enron and other corporate accounting scandals, Arthur Andersen collapsed. GT welcomed 60 partners and hundreds of staff members from the defunct Big Five accounting firm, and GT began a revenue surge that hit growth rates of 52% over 2003 and 2004, for instance.

“Grant Thornton benefited from being at the right place at the right time, because the fall of Andersen created a little bit of anti-Big Four feeling,” Barton says. “Clients began wondering if they could get a better value from a next-tier firm.”

Similarly, Rothstein Kass went through a period of strong growth, gaining such status among venture capital and private equity clients that KPMG acquired it in July 2014. As the finance chief at RK, Barton helped wind down the firm’s operations in preparation for the acquisition, he said in a recent interview with CFO.

In the first article based on that interview, he tells why, although he was offered a job at KPMG, he chose to become Goodwin-Procter’s finance chief. In this, the second article, Barton describes the inside workings of audit firms from the perspective of a finance executive. Following is an edited version of part of the interview.

What’s the ownership structure like at audit firms?
They’re often structured as partnerships. A partnership has a governing document, a partnership agreement, that you sign when you are promoted to or join the firm as a partner. Every partner in the firm is an owner of the company. They get shares, or what’s called units, in the firm. You have senior partners that have more units and junior partners that have fewer units. And a lot of firms have what’s called a two-tier partnership in which equity partners hold most of the units. Most firms have another level of partner called an “income partner” or a “non-equity partner,” which is largely salaried and might get either no units or a few units, depending on the firm.

There’s a unique aspect to being the CFO of a partnership. When I left Grant Thornton there were about 580 partners. In any given day, on the bad side of it, you have 580 bosses. It doesn’t usually come across or feel that way particularly in a firm with a positive culture, but they all own a piece of the firm. They don’t take salaries. They get a percentage of the profits, if any, at the end of the year. If there are big profits, they share in them. If the profits drop dramatically in a year, their personal financial statement, their K-1, reflects that.

How is compensation disbursed throughout the year?
The way I’m familiar with was that we would put together a budget for the year that contained our expectations of the profits and unit earnings of the firm. We would then give a portion of that every month to the partner as a monthly draw on their future earnings. Since the partners are owners rather than employees, they have to pay for their own medical benefits, for example, at the end of the year. A lot of firms will pay for the compensation and benefits on behalf of the partners throughout the year, [then] charge them for their benefits as a percentage of their earnings.

What’s the typical management structure at an audit firm?
Usually, there is an elected managing partner who operates as a CEO and helps manage the operations of the firm. And there will be usually be an elected partnership board with a chairman who helps the managing partner. The chairman and the partnership board will look at things that really impact the partnership in general or that represent risks to it. If the firm was going to take on debt, look at a major acquisition, or bring on a large group of partners who would have large amounts of units – those are the types of things that might be reviewed by the partnership board.

The ironic part about the partnership board is that it’s made up of people who serve on a rotational basis. The managing partner of the firm would on some level report to, and be evaluated by, the partnership board at the end of the year. In many cases, you would have a line partner from the Carolinas practice, for example, be on the partnership board. And the CEO or managing partner was the line partner’s boss’s boss. But when it came to compensation, such line partners sat over the CEO.

What kind of financial reporting responsibilities did you have as the head of finance at GT?
Monthly internal financial reporting was the majority of it. The head of the New York office was running a business and he got a P&L for the New York office. The head of Chicago got a P&L as the head of Chicago. Underneath that, the head of Chicago audit also got a P&L for Chicago audit. From the major management standpoint, the head of tax across the entire U.S. firm got a P&L for tax. So they all could see what they were managing.

We were going through a monthly close process, producing monthly financials and dashboards. But we were also producing monthly metrics packages and benchmarks, analytics to understand resources such as productivity and utilization, as well as the client. You were really looking at the business itself, the people and the client sides, on a monthly basis.

As the head of the central finance function you provided them with financial statements?
Yes. And then on an annual basis, the partnership board had a finance subcommittee that would review the budget each year. They also elected a rotating group of partners that would do an internal audit, because most accounting firms do not want to invite another accounting firm in to audit their books. Sometimes the group might recommend changes, but in most cases, they would not make any notes.

Then there would be an annual close process that produced internally audited financials. If the firm determined, for instance, that we made $100 a unit, the books weren’t officially closed until that partner review team analyzed the firm financials and said the firm did make $100 a unit. Then we were good to go, and we closed the books, and everyone was paid out.

No external audit of any kind?
No. But we would provide financials externally to our banks. If we had a revolving line of credit we would release financials to our banks and to other interested parties, depending on what relationships we had with them. I was also involved with the release and management of the external financials. I was talking primarily about Grant Thornton, but when I was at Rothstein Kass we did not have outside auditors come in and audit the books at year end.

The compensation agreement and the year-end closings with the partners sound like a big part of the responsibility of the CFO at an accounting firm. Was it ever a source of friction between the members of the firm and the finance team?
If it’s well done, the closing part becomes largely formulaic. By having transparency of information throughout the year, when it gets to year-end, most partners should have a pretty good idea of what their compensation would be. About two months before year end, I would start getting emails from all the partners that I was friends with — and even more from the ones that I was not friends with. They were asking, “What are the earnings per unit going to be?”

They knew their income that year was going to be in a range. But they didn’t know exactly what it was until the books were closed. And they didn’t so much question the process as they wanted to know about such things as should they be buying a bicycle or a car.

Did you give them that information? Was it hard to decide how much to reveal?
We followed standard rules of disclosure, depending on the management team in place at the time. There were some management teams that would share nothing, because they do not have open — or have only partially open — compensation systems. Most partners do not know what other partners make, with the exception that all partners have to ratify the managing partner and the partnership board’s compensation. So they basically know the compensation of the top eight or 10 people in the firm. But no one knows anyone else’s.