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Evaluating Clients – Part One – Why you should evaluate clients?

It’s tough to find new clients so any new opportunity is usually a good thing – particular if the client comes from a referral. But even good things require a degree of scrutiny and prudence. Today’s litigious society means that some people are lawsuit happy; some are dishonest; some are even crooks. These are not desirable clients. The best clients can benefit from your firm’s expertise and talents, and this does not apply to every prospective client.

The following blog postings discuss not just the screening of prospective clients, but the evaluation of current clients. Declining potentially problematic clients is an excellent first line of defense, but the source of most lawsuits is existing clients. More than 75 percent of lawsuits against CPAs are filed by directly by clients and the balance arises from the actions of clients. There is a strong possibility that one current client is considering a lawsuit against your firm. But do you know how that client is? Do you know how to protect yourself from a lawsuit? The following will provide you with guidance on how to find clients that are well matched to your firm.

What If You Don’t Evaluate Clients?

Failure to evaluate a customer mean the quality of your client group is reduced, and that could lead to an increased risk of the following:

  • Not getting paid – a CPA should get paid fairly and on time. If you have to sue to collect there is a strong possibility that your client may countersue.
  • Being sued – in today’s litigious environment it almost doesn’t matter if you’ve done anything wrong. If someone’s lost money and is trying to recover it, the CPA is a good target for a lawsuit. Even the most unfounded cases can require a significant amount of time to settle. Lawsuits involving accounting procedures are complex and hard for juries to understand. Defense costs are expensive. Gathering facts and witnesses consumes a lot of unbillable time. Papers associated with the client must be reviewed, and procedures must be documented and presented for the opposing attorney’s scrutiny. Even if it seems like an ironclad case, verdicts can be unpredictable and awards can exceed your insurance limits. In addition, people hear about and talk about lawsuits. Even if you are found innocent, the fact that you have been sued can impact your firm’s reputation.
  • Morale problems – Taking on risky clients could be controversial and cause stress among your partners and staff. A malpractice lawsuit can generate a lot of accusations that can be extremely upsetting and undermine your firm’s internal morale. Time and energy spent investigating the facts and resolving issues with difficult clients is time lost on developing more profitable opportunities.

Methods of Client Evaluation

But what is the most efficient way to assess clients? How can we make this process efficient and fast? Current clients are relatively easy to evaluated, but most CPA firms can’t spend weeks evaluating new clients.

Informal Screening of Clients and Potential Clients

Informal screening can be a route to avoiding risks. Annual purging of any difficult clients may mitigate the possibility of a lawsuit. Alternatively, some CPAs take an intuitive approach and go by gut feeling, trying to sense if a client may be potential trouble then conduct further research to verify intuition and eliminate a future problem.

Informal screening methods are fast and relatively simple, but they have their drawbacks.

Business planning argues for selecting clients that fit the firm’s skills and the strategic direction of the firm. Efficiency and impartiality argues for standardized evaluation criteria that can be applied to all clients. The intricacies of today’s accounting practice, the complications of continually changing regulations and tax codes, and the liability climate argue for a thorough client assessment process – not just a cursory look at a few clients at occasional intervals.

Formal Screening

You may consider screening of your clients as an arduous task, or you can look at it as a way to enhance your firm by improving your relationships with your clients. The latter approach is obviously the better one. Also a conscientious attitude toward evaluating clients is representative of your standard operating procedure – and most clients prefer accountants who are careful and thorough.

In addition, it is an opportunity to explore what the client needs and to offer additional services.

Finally, using a designed approach to client evaluation that feature thoughtful discussions is a means to improve relationships with your clients and start relationships with potential clients on a positive note.

You will discover important information in your evaluation process. For example:

  • The client has survived a downturn in their marketplace; however, it is actually not in good shape. A few inquiries may help you avoid the inevitable claims fallout if the client files for bankruptcy.
  • Changes of key personnel at the client can be a signal that there is pressure on performance, or staff is being asked to do things they are unwilling to do. This is worth investigating.
  • The client is beginning to suffer from changes in its industry. If you fail to anticipate these, you may later be accused of negligence or fraud.
  • The client has a growing number of transactions with closely-linked parties, and/or the client’s transactions with closely-linked parties are steadily increasing in size. This could point to fraud.
  • The client is rapidly increasing its debt load. If it gets into serious trouble, third parties may hold the accountants responsible.
  • Other cash flow or profitability problems are pressuring owners and managers. Again, fraud could be a by-product.

Using a Formal Screening Process

Meet with your clients. It can be very helpful to start your evaluation of important existing clients. Approach the meeting as a way to gather data and promote your firm’s professionalism: you want to find out if there are any problems, while at the same time letting your clients know that they are Important to you and you value their contribution. Claims data suggests that regular communication and solid relationships are important cornerstones for dealing with the inevitable issues that arise on an engagement, and that the stronger the relationship, the more likely the issues can be settled easily.

A focused conversation is an excellent way to reveal problems impacting a client’s business that may not have shown up in earlier meetings or have only recently materialized. These problem areas are essential for you to know about in order to pre-empt potential troubles. Issues detected early can be mitigated and you can take early measures to assist your client and/or avoid becoming drawn into the problem. Whether you conduct the meeting via telephone or face-to-face, you’ll want to ask questions such as:

  • “What changes in your business do you anticipate over the next year?”
  • “Do you see your needs for our services changing?”
  • “Are you satisfied with the quality of services that we have provided you?
  • “Can you suggest any areas that our firm could improve?”

If you have experienced problems in working with the client (late or non-payment of bills, inadequate provision of information, etc.), you will need to discuss this with the client to determine:

  • Are they aware there have been problems?
  • Are they willing to help address the problems?
  • What can they do to do to fix the problem?
  • Is there anything your firm can do to help?

You already have a lot of information about your existing clients, of course. Yet anyone who runs a business has clients that they admire, clients that are more interesting, clients with whom they feel a greater sense of comfort. The evaluation process is designed to get you to try to look at them objectively. If the client walked in the door tomorrow, would you want them, knowing what you know about them already? If the answer is no, you should consider dis-engagement.

Be mindful that things can change over time. A client taken on a decade ago may be a completely different business than the one you’re serving today. Part of the firm’s risk management and business strategy should be monitoring your clients for significant changes.

  • Is the client now publicly traded, or an increasing third party reliance on your work product? The more people who look to your firm’s work product for making decisions, the more possible plaintiffs there are for a lawsuit.
  • What is your opinion of about the management team? Personnel changes occur, and if current management lacks integrity in the way they deal with you or their employees, suppliers or others, you need to be circumspect
  • Do you know your client management team as well as you should? Is there a new member on the Board of Directors? Has the audit committee changed? You will work better with your clients if you know each other.
  • Does the company engage in transactions with entities under common control or with other related parties that are not or will not become clients of the firm? Your lack of knowledge about what these other entities are doing can subject you to serious risk to you.
  • Is the client encountering financial difficulties? Your firm can play an important role at a time like this, but must be careful not to -go down with the ship: In other words, your client’s problems are their problems, not your problems – keep it that way.
  • Are the client’s internal controls careless? Internal controls may have fallen behind during a period of rapid growth. For example, if revenues have risen dramatically, and a small team is still handling all the accounting functions, there is potential for fraud. A prudent CPA can anticipate this and advise the client, so that failure to detect a defalcation is not later blamed on the accounting firm.
  • Does the client pressure the engagement team? Does the client insist on taking aggressive positions? You may be able to stand up to the client, but maybe one of the less experienced associates won’t be able to. Don’t dismiss combative clients as just They can be the root cause of problems problems.
  • Is the client’s accounting staff incompetent and able to be manipulated? Perhaps management may like it that way but it should make you suspicious of their data and your job more difficult.
  • If this is a relatively new engagement, has the client changed CPA firms often in the past? If so, it implies the client lacks commitment to a strong relationship. It may mean the client left in a huff when the results weren’t what he or she wanted, refused to pay bills, or was simply impossible to please. It probably means you have a challenging client.
  • Have there been recent changes in other client business relationships, such as banking relations, outside legal, counsel, brokerage accounts, related and affiliated parties? Changes can mean suspicious activities are taking place. Investigation and prudence are advised.
  • Does your firm have the expertise required to do the work? Has your client grown dramatically, purchased a dissimilar business, or branched off into a new area? Has the CPA originally responsible for the client left your firm? If you find yourself without adequate comprehension of the client’s business, or without expertise in the accounting work required, you are in a very vulnerable position. Chances of making mistakes are aggravated.
  • Does the client represent a significant percentage of your firm’s revenues? Ask yourself if you’ve made a special exception for the client, doing things for them you would not, in prudence, do for others. Balance the risks of what you are doing for the client against what the client is doing for you. Think about diversifying to reduce your vulnerability.
  • Are the tax client’s records in poor condition? Your conclusions based on inaccurate or incomplete information could come back to haunt you when big penalties are levied.
  • Are the client’s goals unrealistic or unclear? If a financial planning client, do they understand how risk relates to return? If a computer consulting or MAS client, do they understand what is possible? Do they know what they want? Failure to pin down these issues may mean extra, unplanned work or that they come to you to be made whole after a loss.
  • Is the client in a high-risk or volatile industry? Is the client highly leveraged? Extra caution during engagements and attention to keeping your receivables current are prudent.
  • Are there any recent regulatory changes that impact your client? Does your client have the financial ability to meet new regulations? If not. What does your client plan to do? Penalties or fraud may be the result.

No client is perfect. The point of the evaluation exercise is not so much to find fault as it is to know exactly who you’re working for and act accordingly. Examine your relationship to see if it warrants changing. Talk to your client about what you need to improve the relationship. Set forth the details in a new engagement letter when your evaluation screening is complete.

Next month – Part two – Evaluating Potential Clients.

 

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