Observations on the health of the accountancy sector

Transcription

1 Corporate & Commercial Observations on the health of the accountancy sector 2015 Financial Benchmarking Report Accountancy Firms First survey

2 Foreword Three years ago NatWest, in association with Robert Mowbray, developed its first Financial Benchmarking Report Law Firms. The report is now published annually and looks to examine, specifically, the performance of law firms with revenue of below 30 million. Because the report only focuses on law firms operating at the SME level, it has proved to be enormously popular. In response to increasing demand, the bank has now delivered a similar publication that benchmarks the financial performance of accountancy firms generating fees of less than 30 million. It is estimated that the UK supports over 12,000 accountancy firms, with more than 70 per cent of those employing less than five people. This report is designed to help those firms sitting outside the top 50 to reference their financial performance against their peers at both a national and regional level. With this insight, we believe firms can target areas of improvement in order to enhance profitability and improve working capital management. Arguably, the accountancy sector has performed reasonably well in recent years, despite the economic headwinds and allowing for the relatively inelastic demand for audit and tax services. Against the improving economic climate, the immediate future looks positive, although compound revenue growth is predicted to be modest at 3.1 per cent. In this report, we also identify that the average partner in an accountancy firm generates fees of 435,000, at a net profit margin of 25 per cent, thereby delivering a profit per equity partner (PEP) of 108,000. How does your firm s performance compare? We are delighted to be able to deliver this report for the benefit of the typical UK accountancy firm, and certainly those resting outside the top 50. In doing so, NatWest hopes to reinforce its continued commitment to firms delivering professional services a commitment that is underpinned by providing access to Relationship Managers who understand the accountancy sector and your business, and who benefit from accredited training. We would like to thank Robert Mowbray for sharing with us his sector knowledge and support in producing our inaugural Financial Benchmarking Report Accountancy Firms. If you have any comments about the report, or would like to discuss how NatWest can assist your accountancy firm, please do not hesitate to contact me. Steve Arundale Head of Commercial Professional Sectors, NatWest, About the author Robert Mowbray is a Chartered Accountant who has worked in, and for, professional firms for more than 30 years. His involvement with law firms began in the late 1980s and quickly developed into a niche business. His book entitled Maximising the profitability of law firms, published in the mid-1990s, was the first book on law firm financials. He has been involved in a large number of surveys in the legal profession which have focused on the financial health of firms, and he has worked on other surveys to research other aspects of law firm performance. He is also the author of Law firm finance & administration handbook A practical guide for COFAs and finance professionals which was the first book to be published on the role of compliance officers for finance and administration (COFAs). Robert also has considerable knowledge and experience of the accountancy sector, having trained at Price Waterhouse & Co before spending time at Buzzacott & Co. He was a partner at Macintyre Hudson for 20 years. Each year, Robert works with some 80 professional firms and helps them to improve their financial performance. He has assisted in many areas, including: improving the quantity and quality of time capture; improving the ability of fee earners to negotiate fees with clients and to introduce more creative fee arrangements; managing lock-up to improve cash flow; profit sharing arrangements which reward improved business performance; and strategic and business planning. Robert has worked with around 1,000 professional firms across more than 30 countries. His clients range from the global elite through to major regional firms, as well as many small firms and sole practitioners. He is an owner of Taylor Mowbray LLP a business that focuses primarily on professional firms which he runs with Janet Taylor, who is an authority on the SRA Accounts Rules. 2 Accountancy Firms Financial Benchmarking Report 2015

3 Ove r vi ew Executive summary The survey is a substantial review of accountancy firms with fee income of up to 30 million. From across England, Wales and Scotland, 184 firms, employing 6,900 people, took part in the survey. Their combined total income was 518 million. Some interesting findings from the survey include: Profits Median profit per equity partner (PEP) is 108,000 the lower quartile is 69,000 and upper quartile is 183,000. PEP has grown by 7% from last year, and is rising considerably above inflation. The growth of profit in small firms is significantly better than that of large firms. The median figure for profit as a percentage of fees is 26%, with an upper quartile figure of 34% and a lower quartile figure of 18%. Firms structured as LLPs are more profitable than those structured as companies or traditional partnerships. Productivity continues to be poor: the median figure for recorded chargeable hours per fee earner is just 1,000. Fees Annual fees per equity partner are typically 435,000; in very large firms, the figure is almost double at 857,000. Fee income is up by 3% on last year. Fees per fee earner are 137,000. Lock-up The median firm takes 120 days to turn time spent into cash. There is no significant change to lock-up across small, large and very large firms. Finance The median bank balance at year end was 19,000, which confirms that most accountants do not like debt. Partner capital is typically 31% of annual fee income. Comparison with law firms PEP within accountancy firms is 1,000 higher than within law firms. At 120 days, lock-up in accountancy firms is worse than in law firms where the figure totals 109 days. Contents Introduction p6 Fees p8 Profit p11 Lock-up p19 Finance p22 Conclusion p27 Accountancy Firms Fin a n c ia l Ben c h m a rkin g Rep o rt

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6 Introduction Accountants often spend considerable amounts of their time commenting on the financial performance of their clients, without necessarily spending much time reflecting on the performance of their own firm. This survey attempts to define the main financial benchmarks for the accountancy profession, and to provide data that should help firms operating at the SME level to effectively benchmark their own performance. In writing the report, I have spoken to many accountants from firms of all sizes, located throughout the UK. I have talked to people who have been in practice for many years, and to those who have only recently set up a firm. Not surprisingly, views differ on how firms can improve their profitability, and what the major threats facing firms are likely to be in the coming years. At the very least, it would seem that the pressure on fee levels is unlikely to go away. As Cloud-based and other accountancy software systems become simpler to use, but more sophisticated in what they can do, there is also a client expectation that fees should fall. So it has been challenging to move away from the traditional compliance work, towards value-added consultancy-type arrangements. Thus firms need to focus on productivity so that they can deliver profitable services, and invest in their staff and technology so that the best people are not enticed away. Clients will pay for a good service and so firms must focus on how they can differentiate their offering if they are to attract premium work. Developing a real specialism, or niche business, is going to help and this can be done by even the smallest firms. Professional firms also continue to struggle with managing their lock-up so perhaps it is time to start talking to clients about a monthly cost, rather than an annual fee? Another major, and rapidly growing, issue in many accountancy firms is succession. Since the economic crash, partners have become seven years older and not many new partners have been admitted. Firms are going to have to think about how they can attract younger people into partnership when they might be tempted by alternative jobs in the City or in industry. A possible growth strategy for some firms is to buy client lists from smaller firms as the partners there look to retire. As I have also been the author of the NatWest Financial Benchmarking Report Law Firms for the last three years, I have been able to compare the performance of both accounting and law firms. I did not know which profession would perform better financially, but I understood that everyone would have their view. This survey demonstrates where the differences exist. The data was collected by NatWest from its customers. The table below shows that the survey has reviewed the results of 184 accountancy firms spread fairly evenly across Scotland, England and Wales. In order that benchmarks can be fairly set for different sized firms, the survey identifies firms as either small or large. Small firms have a fee income of less than 1.5 million per year, while large firms generate a fee income of more than 1.5 million per year. Because the firm with the highest fee income in this survey generated fees of 30 million, our report provides information for very large firms which are defined as having fee income in excess of 5 million per year. Results for these very large firms are also included within the data for large firms. The report provides median, lower quartile (LQ) and upper quartile (UQ) figures. Firms want to be the best at everything but this is clearly unrealistic. Firms also tend to talk about what they are good at, and try to get even better at this, rather than focusing on areas of under-performance where improvements might be more easily be achieved. When looking at the tables, it is perhaps best to focus on the areas where your firm is currently below the upper quartile figure, and to think about what needs to be done to generate better results. The information in the report is historical as it relates to the most recently ended financial year, and it is segregated into five regions. The total figures are built from all of the data, but the regional figures are compiled from less data and are therefore less reliable. While you will be interested to see the regional variances, it is probably best to initiate the benchmarking of your firm against the total figures. 6 Accountancy Firms Financial Benchmarking Report 2015

7 Overview Table 1 shows an analysis of the firms in the survey by region and by size. Three regions were grouped together to form Wales, Midlands and East of England as there were not enough firms in each of these regions to be analysed separately. The survey has divided the firms into two sizes: those with annual fees of less than 1.5 million are described as small, while those with fees in excess of 1.5 million are classified as large. Very large firms generate annual fees in excess of 5 million the results for these very large firms will be included in the figures for large firms Firms by location Scotland North East, North West TOTAL BUSINESSES 86 SMALL 98 LARGE 184 TOTAL Wales, Midlands, East of England London, South East VERY LARGE FIRMS 23 TOTAL South West London, South East 36 2 Firms by constitution South West Wales, Midlands, East of England North East, North West Scotland TOTAL PARTNERSHIP LLP COMPANY SOLE PRACTITIONER TOTAL Table 2 shows the breakdown of firms taking part in the survey by legal constitution. The most common type of firm is a firm trading as a limited company and this accounts for 42% of the firms in the survey. For those still trading as a partnership, it is perhaps surprising to see that there are more traditional partnerships than LLPs. When looking at the very large firms, it is no surprise to see that the proportion of incorporated firms drops to just 19% of the population. Logically, the legal constitution should not have any bearing on a firm s performance, but this report studies whether firms with differing constitutions perform differently and details the results on page 18. Throughout the report, the term equity partner refers to an equity partner in a partnership or LLP or to a shareholder in an incorporated firm. VERY LARGE FIRMS Accountancy Firms Financial Benchmarking Report

8 Section 1 Fees Key questions to consider 1. What do we need to do to enable fee earners to become more productive? 2. Are we training our fee earners properly so that they maximise their fee earning potential? 3. Are we confident about our pricing, and can we charge more if we get the service right?

9 SECTION 1 FEES Fees A firm can make more profit without increasing fees by focusing on controlling and cutting expenditure. This has been the focus in the majority of firms over the last few years, as fee income levels have generally fallen or remained fairly flat. For many firms, now is the time to focus sharply on the growing of fee income to increase profits. As stated in the introduction earlier, this could require a change in thinking generating more income may require a firm to spend more on fee earners, and on supporting overheads such as training and IT. A good measure for fee income is per equity partner (or per shareholder in an incorporated firm) as the owner is likely to earn more by maximising their revenue. TABLE 3. 3 Fees per equity partner ( 000s) London & South East , South West Wales, Midlands, East of England North East, North West Scotland Total for all regions Very large firms ,144 Table 3 highlights the considerable range around this figure. Overall, the lower quartile figure is 324,000, the upper quartile figure is 637,000, and the median figure comes out at 435,000. There is also significant regional variation the highest region (South West) achieves a median figure of 491,000 while the lowest regional figure (Scotland) is 404,000. It is also interesting to see that the median figure of 857,000 among very large firms is nearly double that of the overall median of 435,000. It is perhaps not surprising that this demonstrates how larger firms find it easier to generate more income per partner than smaller firms. This is also evident when you can see that the median figure for large firms is 556,000, while for small firms it is just 332,000. Accountancy Firms Financial Benchmarking Report

10 SECTION 1 FEES TABLE 4. 4 Fees as a % of previous year s fees London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms Table 4 shows what has happened to fee growth. It is reassuring to see that growth is returning and the overall median increase in fees is 3% over the previous year. The upper quartile performance shows a stronger 8% rise in fees while the lower quartile performance shows a drop in fees of 1%. The bigger the firm, the faster the growth in fee income: small firms have increased by 2%; large firms by 4%; and very large firms by 5%. It is interesting, and perhaps surprising, that the total median increase of 3% is repeated in all of the regions except for the south of England (London & South East, and South West) where the increase was 4%. One of the widely used measures of performance in professional firms is fees per fee earner as this demonstrates the level of income being generated by each fee earner. This can then be compared to the salary cost of the fee earner to determine the multiple of salary costs that is represented by the fees generated. When budgeting, good firms have always talked about the need to achieve fees equal to three times that of fee earner salary costs in order to get healthy profits. If this can be done, and a further third is spent on overheads, then a healthy net profit of one third is earned for the equity partners. If a multiple of three times salary cost is not achieved, then it will be difficult to reach the same level of profits. Clearly, if productivity can be increased and the multiple is higher than three, then it should be possible to make even higher levels of profit than have been achieved historically. TABLE 5. 5 Fees per fee earner ( 000s) London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms Table 5 shows that the overall median figure is 137,000; in small firms, the median figure is 131,000 and in large firms, it is 142,000. It is surprising to see that the equivalent figure for very large firms is 140,000. The breakdown by region is also not what might have been expected: Wales, Midlands & East of England have the highest median at 177,000, while North East and North West have the lowest median at 80,000. These are significantly different figures. This disparity could be explained by the fact that some larger firms are paying higher salaries, but it may also reflect improved productivity. Perhaps the most interesting information in this table is the difference between the lower and upper quartile figures. The total figure at the upper quartile level of 244,000 is more than three times the lower quartile level of 77,000. This is likely to make a huge difference to the profitability of the firms surveyed. Looking forward, it is clearly important to measure fees per fee earner and to look at new ways of improving productivity. 10 Accountancy Firms Financial Benchmarking Report 2015

11 Section 2 Profit Key questions to consider 1. Have we benchmarked our performance against comparable firms and have we identified where we are below the upper quartile point? 2. Are we under-recording our time, and therefore not showing clients the full extent of our efforts? 3. How can we get a better rate per hour for what we do, and do we understand creative fees? 4. Do we use matter planning tools which help us to understand the profitability of the work we are doing? 5. Do we have a clear strategy?

12 Profit Profit is the most important measure in any firm as it is the profit which is shared among the partners. It is amazing how many firms focus too much on fees and not enough on profit. Historically, this has been because firms have always found it easier to measure fees billed than to calculate the profit earned for different types of work both for individual matters and for different fee earners. This has resulted in some strange behaviours, with many partners being too focused on the size of their fee portfolio rather than the profit being made. Table 6 looks at profit per equity partner and shows that, of the firms surveyed, the overall median profit per equity partner is 108,000. However, the variance within this figure is significant: the lower quartile figure is 69,000 and the upper quartile figure is 183,000. There is also a very significant difference between the median figure for small firms at 77,000, when compared with the median figure for large firms which is almost double at 155,000. The median figure for very large firms was 212,000. There are also some notable differences by region: the median is highest in London & South East at 153,000, compared with the South West where the median was less than half of this figure at 72,000. TABLE 7. 6 Profit per equity partner ( 000s) London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms Accountancy Firms Financial Benchmarking Report 2015

13 SECTION 2 PROFIT TABLE 8. 7 Increase in profit per equity partner from previous year (%) London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms Table 7 shows the change in profit per equity partner (PEP) from the previous year. Overall, the median figure has increased by 7% which is confirmation that most firms are starting to see a rise in profits that is well above inflation. This will be welcome news after a number of more difficult years. The increase within small firms has a median figure of 15% which is significantly higher than the median increase of 4% in large firms, and 1% in very large firms. The South West has seen the largest increase at 12%, while Scotland saw the smallest increase at 5% although even this is still above inflation. It is also interesting to see that the overall upper quartile figure was a 19% increase this tells us that many firms are seeing significant profit per equity partner increases. Traditionally, well-performing professional firms have aimed to generate a third of their income as profit, while average firms have recorded profits of just under a quarter of fee income. It has always been believed that a good firm can bill out fee earners at three times their salary cost, allowing a third of income for the right overheads to support the fee earner, and to ensure that the client receives the right service. This results in a gross margin of two thirds and a net margin of one third. The big driver of profitability in all businesses is productivity, and firms should therefore measure the relationship between the fees generated and the cost of employing the fee earners. A net margin of a third is significantly better than would be achieved in most businesses. However, it is not really a fair comparison because there is generally no salary deduction for the equity partner in an accountancy firm. If a notional salary was to be deducted, then the profit figure remaining would look less positive and the partners might challenge their ability to generate a real profit. TABLE 9. 8 Profit as a % of fees London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms Table 8 reveals the net profit margin, as a percentage of fees, being earned across the country and among different sized firms. The results are very close to traditional figures and may suggest that the difficult years are now behind accountants, and that more predictable profits can be expected in the future. Accountancy Firms Financial Benchmarking Report

14 SECTION 2 PROFIT Table 9 looks at the percentage of partners that are equity partners. The figures reveal that there are not many fixed-share or salaried partners, particularly in smaller firms. As firms become larger, a greater proportion of non-equity partners are likely particularly when looking at the figures for very large firms. TABLE Equity partners as a % of total partners London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms One of the issues that will influence profitability is the relationship between the number of fee earning and non-fee earning staff. Fee earners need to do the fee earning and should not be dragged into more non-fee earning work than is absolutely necessary. Table 10 shows the percentage of fee earners within a firm s total headcount. The overall median figure is 50%, dropping to 46% in small firms, and rising to 64% in large firms and 74% in very large firms. This significant variance among different sized firms could be a reflection of economies of scale, but it certainly helps to explain why larger firms tend to be more profitable per equity partner. Other surveys published recently for the Top 30 UK Accountancy firms have suggested that these firms get even closer to 80% of all staff in fee earning roles. TABLE Fee earners as a % of total headcount London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms It can be easy to get lost in the detail of a set of accounts, so it is important to focus on the key measures of performance. The profit per equity partner (PEP) in all firms is equal to the multiple of four variables, as the following model demonstrates: 14 Accountancy Firms Financial Benchmarking Report 2015

15 SECTION 2 PROFIT Understanding and benchmarking profitability An example model: 4.00 PEP = GEARING 5.00 SMALL FIRM PEP = 96,000 1, X HOURS X RECOVERED RATE/HOUR 1, LARGE FIRM PEP = 504,000 X 20% PROFIT MARGIN 30% Variable 1: Gearing The first variable is referred to as either gearing or leverage. It is a number, representing the size of each team in the firm including the equity partner. So, if a partner manages two fee earners, they have a gearing of three; if they manage five fee earners, they would have a gearing of six. Clearly, the larger the team, the more it can bill and the more profit it can make. The reason why gearing is not normally a high number is to do with the complexity of the work. Only simple accounting and tax work can be done with huge gearing; more complicated work requires more supervision and experience. Variable 2: Chargeable hours The second variable is the annual recorded chargeable hours per fee earner. If everyone is busy, and confident in recording their time, then the number will be high. If there is a shortage of work, or if people are slack over their time recording, then the recorded hours will be lower. It is not surprising that the firms who pay the most seem to get the most hours recorded. When the first two variables are multiplied together, you are calculating the annual hours generated by each partner through their team. Accountancy Firms Financial Benchmarking Report

16 SECTION 2 PROFIT Variable 3: Recovered rate per hour The third variable is the recovered rate per hour billed. The higher this rate, the greater the profit margin. Clearly, complex work can demand a higher rate than routine tasks. Some firms like to break this variable down into the recorded rate and the percentage of this rate that has been billed. In other words: Recovered rate per hour Recorded = rate per X hour Realisation % (With realisation % being the percentage of time recorded that can be billed) The multiple of the first three variables determines the fees billed by the partner in the year. Variable 4: Profit margin The final variable is the profit margin. This is the percentage of the fee that ends up as net profit. It is the efficiency with which a firm turns fees into profit. If the firm is efficient, then the net profit margin will be high, whereas inefficiencies can cause the margin to drop into negative figures. The numbers used on the previous page show that to go from a PEP of about 100,000 to a PEP of about 500,000 does not require a fivefold increase in all of the variables. Relatively small increases in one or more of the variables can deliver very significant improvements in profitability. This is why firms should regularly benchmark against their competitors so that they can identify where they can most easily improve. Gearing is the total number of fee earners per equity partner (total fee earners, including equity partners, divided by equity partners) and is reviewed in Table 11. It is clear that if a partner can manage a larger team, they can bill more and generate greater profit through that larger team, whereas a partner working alone limits the billings that can be generated and the profits earned. It is the complexity of the work that is being done which will ultimately limit the level of gearing that can be achieved. In other words, if an accountant is doing complex international tax, there would be less chance of achieving higher gearing than if they were doing simple tax returns for individuals. Table 11 shows just how much the gearing figure differs by size of firm. The total median figure is 3.00 while the figure for small firms is 2.30, for large firms 4.00 and for very large firms Very large firms are geared at over three times the level of small firms, despite the fact that larger firms are normally doing more complex work. This tends to suggest that small firms should be looking to grow fees and gearing considerably, before looking to extend the partnership. There are also some significant regional variances North East, North West has the highest median gearing at 5.00, and Scotland the lowest at These figures show that it is not simply about getting the numbers right; it is important that the whole team is very good so that staff can all trust each other. Partners, therefore, need to commit more time to recruiting the best people, to developing these people further, and to ensuring that they remain at the firm for longer. 11 Gearing London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms Accountancy Firms Financial Benchmarking Report 2015

17 SECTION 2 PROFIT The second variable which influences profit per equity partner (PEP) is the annual recorded chargeable hours per fee earner. If fee earners can focus on their client work, they are likely to be more productive and more profitable than if they are spending considerable amounts of time on administrative tasks. The number of hours that can be recorded will be driven by the number of hours that people are working. Firms that pay top salaries will find it easier to ask their staff to put in additional effort, whereas firms paying normal salaries are less likely to develop a long hours culture. Even if a firm is increasingly charging clients fixed fees, it remains crucially important to measure what things cost and this is what can be achieved with efficient time recording. Table 12 shows why effective time recording is so valuable. The overall median figure of 1,000 equates to about 4.5 hours per working day if there are 225 working days per year. This suggests that there is considerable underrecording of time. There are no significant differences within small or large firms, but very large firms have a median figure of 1,096 which is probably explained by higher salaries and a longer working day. If fee earners do not properly record their time, the firm will not know what things cost and will struggle to set fixed fees at the right level. Ineffective time recording also makes it hard for firms to understand the relative profitability of different fee earners, work types and clients. So, how might a firm set about improving the culture around full time capture? Technology can definitely help and there is sophisticated software which watches electronically what people are doing; this can help a fee earner capture more of their time with minimal effort. There is also a need for a time recording policy which provides clear guidance over how time is to be recorded. The policy needs to be supported by a frequently asked questions document, which provides detailed guidance on how common grey areas should be recorded. Firms can develop a good policy through training sessions, which allow fee earners to raise their issues so that the final policy can properly reflect the practical issues that are likely to arise. Used together, education and technology can increase time capture by 10-20% without anyone having to work any harder, which can make a very significant improvement to the profitability of the firm. 12 Chargeable hours per fee earner London & South East 1,000 1,022 1,227 1,103 1,122 1,153 1,000 1,110 1,176 South West 1,000 1,067 1,267 1,000 1,143 1,243 1,000 1,100 1,267 Wales, Midlands, East of England 1,000 1,000 1,121 1,000 1,000 1,140 1,000 1,000 1,143 North East, North West , , ,132 Scotland 1,020 1,430 1, , ,000 1,200 Total 926 1,000 1, ,000 1, ,000 1,187 Very large firms 950 1,096 1,193 The third variable which determines PEP is the recovered rate per hour. If the work is more complex, then a higher rate will be payable than if the work being done was routine. Firms clearly need to get smarter at planning how to work most efficiently. For this to be successful, plans must link in to available know-how and use IT in the most effective ways. Once upon a time, preparing a set of accounts would have been a fairly expensive exercise but now, with good accounts production software, good checklists and effective delegation, the accounts can be prepared at a fraction of the original cost without compromising on quality. Accountants will still try to charge on a time-spent basis but most clients will expect certainty and a fixed fee. When fees are fixed, pricing variance still persists across the market. Accountants need to become more skilled at selling the value of what they are offering rather than simply pricing work based on what it costs. Sophisticated clients are often great negotiators, and accountants need to develop their skills in fee negotiation and alternative pricing methodologies if they want to remain busy and profitable. If they don t, they are likely to become busy fools. As fixed prices become more commonplace, many accountants feel that time recording becomes less important. In fact, the reverse is true when the price is fixed, it is vital to keep accurate time records in order to understand the work s true cost. Accountancy Firms Financial Benchmarking Report

18 SECTION 2 PROFIT Table 13 shows us that the overall median rate per hour is 119. Less information was collected for this variable in the survey and therefore it is not possible to further analyse these figures into small and large firms. However, there is a considerable difference between the lower and upper quartile figures. This could be explained simply by work being done with differing complexity, but it is more likely to reflect efficient working practices and the confidence of the firm when it comes to pricing and fee negotiation. 13 Recovered rate per hour ( ) REGION SMALL LQ Median UQ London & South East South West Wales, Midlands, East of England North East, North West Scotland Total There is always considerable debate about what is the most appropriate legal constitution of a professional firm. Traditionally, most firms were partnerships as this was usually the most tax-efficient structure in which to fully distribute profits. Things have moved on and, while there are still traditional partnerships, many firms have moved to LLP status or have incorporated. Although there are good reasons for choosing any of these structures, the primary focus should always be on running a profitable business rather than worrying about the structure of the firm. When working out the profit per partner figure for a company, any salaries paid have been added back to the profit so the figures are comparable to those seen in partnerships and LLPs. Table 14 shows us that the median total figure within LLPs leads at 127,000 per partner. This is perhaps not that surprising because the larger firms, which tend to be more profitable, are most commonly structured as LLPs. It is often easier for smaller firms to incorporate where there are less likely to be partnership changes. The small number of sole practitioners in the survey have been included within the partnership figures. 14 Profit per partner by legal constitution Partnership LLP Company Total Very large firms Accountancy Firms Financial Benchmarking Report 2015

19 Section 3 Lock-up Key questions to consider 1. Given that clients don t want nasty shocks when they are billed, why do we wait so long before we talk about money? 2. Do fee earners have the necessary management information available to manage lock-up? 3. Are the appropriate carrots and sticks in place to deliver improved lock-up?

20 Lock-up Accountants understand finance and the need to have either capital or borrowings to finance assets. Indeed, they will castigate clients who fail to manage their working capital well, because they appreciate that this can lead to poor cash flow and problems with banks and other finance providers. It is therefore quite ironic that accountants are not particularly good at managing their own working capital. The figures used in the report are year-end figures. These are likely to be better than at other points in the year, as firms will have tried to bill as much work in progress (WIP) as possible before the year end. ABLE Work in progress (WIP) days London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms Table 15 shows the amount of WIP days being carried in firms. This is a measure of how long it takes from the recording of an hour to the billing of that hour. The total median figure was 42 days. There is little difference between the figures for small, large and very large firms. The lower quartile figure is 23 days and the upper quartile figure is 70 days. This threefold difference shows that surely many firms can do more to control this variable. To bring WIP days down to much lower levels, it is important to negotiate monthly and interim billing, to actually get these bills out promptly, and to have disciplines which encourage people to focus on accelerating work flow. Having good and accessible management information available to all can also help with the control of WIP. 20 Accountancy Firms Financial Benchmarking Report 2015

21 SECTION 3 LOCK-UP 16 Debtor days London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms Table 16 deals with debtor days this is a measure of how many days it takes to get a bill paid from date of issue. It shows that the median figure for this in total is 75 days (or two and a half months). This is quite appalling and firms should definitely be focusing on what needs to be done to get bills paid faster. It starts with having terms of business which clearly state that bills are payable on receipt, and it is obviously important that bills are agreed before they are sent. Bills should be ed for prompt delivery, and followed up with a phone call a few days later to make sure that they are paid. If they remain unpaid, it does beg the question whether the work should have been done in the first place and whether more money could have been taken up front. My experience is that some start-ups in the profession seem to be better at asking smaller clients to set up monthly direct debits, with a view to being paid in advance of the work being done. Table 17 provides statistics on total lock-up figures. This measures in days how long it takes from a fee earner recording an hour, to the cash being received from the client. We see that the median figure across all firms is 120 days (or four months). It is interesting to see that the upper quartile figure is around five months and the lower quartile figure is almost exactly three months. If a firm is running with fees of 480,000 per partner, it will need capital or bank borrowings of one third of this or 160,000 to finance this lock-up before any other investment could be considered. There is no reason why accounting firms could not bring total lock-up down to well below 100 days if they focused on their own performance in the same way that they do on their clients performance. 17 Total lock up days London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms Accountancy Firms Financial Benchmarking Report

22 Section 4 Finance Key questions to consider 1. Do we have sufficient capital to run the business now, and will we need more capital if the firm grows again? 2. Is it time to look again at our legal structure and how capital is to be retained within the firm? 3. Is it right that we aim to fully distribute profits? 4. Do we need to think again about how quickly new partners are asked to contribute capital, and how quickly departing partners can extract their capital? 24 Accou n ta ncy Fi r m s Fi n a n c i a l Be n c h m a r k in g Rep o rt 2015

23 SECTION 4 FINANCE Finance Despite the fact that many accounting firms have considerable lock-up, accountants are naturally prudent and do not like to take on too much debt. However, just because firms do not borrow too much, it does not mean that they cannot have a cash flow crisis fairly quickly. Table 18 shows that the overall median bank balance at the end of the year was 19,000; the lower quartile figure dropped to an overdraft of 41,000 and at the upper quartile increased to a balance of 130,000. There is little difference between the figures for small and large firms. Such figures highlight that there is certainly room for increased borrowing if firms want to invest in training and information technology as the economy picks up. 18 Year end bank balance ( 000s) London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms Table 19 considers whether firms could run out of money quickly by comparing the unused overdraft capacity as a percentage of annual fees. The total median figure is 10%. This suggests that the median firm would run out of cash if it did not receive any more money from clients in the next 36 days, and if the firm carried on spending all of its money in the way that it has done in the past. Firms at the lower quartile figure of 5% will need to be very careful to avoid running out of cash. 19 Capacity in overdraft as a % of fees London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms Accountancy Firms Financial Benchmarking Report

24 SECTION 4 FINANCE Firms can become less reliant on bank finance if more partner capital is introduced and retained. One way of benchmarking partner capital is to express it as a percentage of annual fees. Given that the median firm has total lock-up of 120 days (see Table 17), this could be financed by having partner capital equal to 33% of fees. Table 20 shows the position for firms and the overall median figure is 31%. When a firm struggles to make budgeted profit levels, it is important that it does look to restrict withdrawals and not just build up deficits on the balance of its current accounts. 20 Partner capital as a % of fees London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms Banks are more comfortable where the percentage of borrowings against partner equity is lower, and where the partners can demonstrate that they clearly have a level of personal financial commitment to the firm. Table 21 shows the percentage of bank borrowings (including borrowed partner capital) as a percentage of real partner capital. The lower quartile figure for small firms is 5%, indicating that there is little debt, while the median figure for all firms is 43%. This figure could be reduced if capital accounts are restored with a strategy to retain profits, which would be a good thing. The upper quartile figure for very large firms is 121% which shows that borrowings are in excess of real partner capital. Firms in this position should think again about their facilities, the amount of capital being provided by the partners, and the ability of the firm to manage lock-up. Their bank may become less happy to continue to provide so much finance in future. 21 Bank borrowings as a % of real partner capital London & South East South West Wales, Midlands, East of England North East, North West Scotland Total Very large firms Accountancy Firms Financial Benchmarking Report 2015

25 L AW FIRM S FINANCIAL B ENCHM ARK ING REPO RT {2013}! 25!

26 Comparison with the legal sector The 2015 Financial Benchmarking Report Law Firms was prepared from the accounts of law firms ending in the same period as this report for the accounting sector. The comparison that follows is therefore not unreasonable. While accountants and solicitors provide different professional services to their clients, they are both in effect selling their time to clients. So which profession performs better? I did not know the answer until I compiled this report, and the comparisons are fascinating. Solicitors generate 9% more fee income per equity partner than accountants. The revenue generated per fee earner is almost identical in both professions. The difference in revenue per equity partner is therefore down to a higher level of gearing in law firms at 3.41, compared to 3.00 in the accountancy sector. The profit per equity partner is almost identical in both professions but accountants performed better by 1,000. Perhaps more interestingly, the margin in accountancy firms at 26% is higher than in law firms where it is 24%. However, it may not be surprising that the expenses per equity partner in accountancy firms are lower at 327,000 than in legal businesses, where the figure is 367,000. Given that accountants will often advise on cost management, it would be worrying if this result had not materialised. Spending more money in the law firm did result in a higher income figure, but the overall result was a slightly lower profit. Levels of chargeable time recorded are the same in both professions at 1,000 hours this equates to just 4.4 hours per day. Both professions should reconsider whether everyone is recording all of their time properly. A lawyer recovers 150 per hour while an accountant recovers only 119 per hour. The two professions might like to debate whether this is because lawyers are providing a more complex service, or because lawyers are more confident when discussing fees. Whatever the reason, accountants should look to maximise recovered revenue per hour because this will boost revenue per fee earner and improve a firm s profitability. Lawyers beat accountants at total lock-up management by 11 days. So perhaps some accountants should take advice on WIP and debtor management from lawyers, rather than the other way around? My career has been about trying to help professional firms to improve their financial performance. Lawyers have always benchmarked against other lawyers, and accountants have benchmarked against other accountants. I hope that this report will encourage both professions to think again and to strive to improve their results next year. TOTAL MEDIAN FIGURES COMPARISON OF TWO PROFESSIONS ACCOUNTANTS SOLICITORS FEES PER EQUITY PARTNER 435, ,000 FEES PER FEE EARNER 137, ,000 PROFIT PER EQUITY PARTNER 108, ,000 PROFIT AS A PERCENTAGE OF FEES 26% 24% TOTAL FEE EARNERS PER EQUITY PARTNER CHARGEABLE HOURS PER FEE EARNER 1,000 1,000 RECOVERED RATE PER HOUR WIP DAYS DEBTOR DAYS TOTAL LOCK-UP DAYS Accountancy Firms Financial Benchmarking Report 2015