No accounting for accountants' accounts

Until a couple of years ago, trying to assess the financial strength of the UK’s major accountancy firms was a frustrating experience. All the firms gave was a standard formula of fee income split into various business areas, and the number of staff and partners. Firms maintained that items such as profit and partner income were no one else’s business but their own.

The mid-1990s have seen a remarkable shift in the UK. Swept along on a tide of corporate governance and openness, pressurised by the trade press and unfriendly Labour MPs, many of the firms are now publishing figures which any financial journalist would have killed for in the 1980s.

Of the major firms, it is perhaps not a coincidence that the two which have embraced this openness with more enthusiasm than the rest are KPMG and Ernst & Young, which are, of course, trying to tie the partnership knot. They have now given clients and prospective clients – as well as rivals and commentators – a great deal of insight into their financial performance. In particular, client FDs have a chance to see whether the fees they are paying are contributing to super-profits, and outsiders have a chance to guess what may be the financial stumbling blocks to merger.

Both KPMG’s and E&Y’s accounts are virtually indistinguishable from their quoted company counterparts, except E&Y’s are unaudited (the different ownership structures clearly also impacts in certain places such as shareholder funds and taxation). On the whole, the words are pretty forgettable. Both firms should promise to look up the Accounting Standard Board’s Operating and Financial Review guidelines and put in a more balanced review of the year in place of some of the marketing guff.

So what about the figures? E&Y’s report covers the 52-week period up to the 27 June 1997, while KPMG reports on the year ended 30 September 1997.

KPMG is by some way the bigger of the two firms. In 1997 gross fees amounted to #726.4m, a 16.5% increase on the year before and 38% greater than E&Y’s turnover, whose fees had grown by 15% over the previous period. The way the two firms set out the consolidated p&l is not exactly the same.

However, KPMG managed what it called “profit available to partners” of #145.4m, while E&Y had “partnership profit before taxation” of #101.8m. Both figures were arrived at after charging direct expenses, changes in work in progress, staff cost, net interest and annuities to former partners.

So KPMG’s profit margin was 20% while E&Y was close behind with 19.4%. On the face of it, KPMG seem to spend more pound-for-pound of revenue on staff costs. E&Y spent 39p for every pound of revenue on staff costs, while KPMG’s figure was 43.8p (one for human resources to look at maybe).

The finance charge was the other major difference: E&Y paid interest in the year of #5.4m while KPMG kept their financing charge down to a modest #400,000.

The cash pile was roughly the same for both firms. It is interesting to note that while the E&Y balance sheet boasts investments of #14m, all held by its captive insurer, KPMG appears to have nothing similar.

A quick glance at the balance sheet reveals work in progress as a major difference between the two firms. E&Y had WIP of #3.6m, up a hefty 126% on the same point in 1996. However, that figure is minute compared with KPMG’s WIP of #51.1m, just slightly ahead of 1996. The work in progress figure consists of staff salary costs and related overheads less payment on account from clients. KPMG also included a small amount of software under development and it states the figure is adjusted for foreseeable losses.

From the report and accounts one can deduce that E&Y are probably twice as efficient at getting the work billed and are apparently better at making the clients pay on account. Memo to senior partners: if the merger goes ahead that’s one E&Y system which should win through. Or is it?

Perhaps WIP is not quite the whole story. The other closely-related figure is, of course, debtors. Today’s WIP is tomorrow’s or, more likely, next month’s debtor. If you talk privately to partners you know that one of the biggest problems the firms face is keeping control of their debtors.

They may be professional global services firms, expert at any topic you care to mention but it seems the partners still shy away when it comes to asking for the dosh due.

The figures show the extent of the shyness. KPMG had debtors of #161m, a 22% increase over the year which given the 16.5% increase in revenues suggests a slight loosening of the credit reins. As for E&Y, its debtors stood at #152m up a mere 10% on the previous year’s figure. However, as for debtor-days, the table (below) tells it all.

The good news is that E&Y managed to reduce its debtor-days by four. If it continues at the current rate it will be down to the commercial average by 2012. The other good news is that despite the fact that KPMG increased debtor-days by four it still got paid three-and-a-half weeks quicker than its putative partner. But still, the time from sending out the invoice to receiving the cash is just a long weekend under three months.

One can really only applaud the creditor management skills of the UK’s FDs. All over the country there are invoices from E&Y and KPMG dated last autumn languishing forgotten in intrays. By the time the most recent invoices get paid we will know the finalists in this year’s FA Cup. Next time an FD is berated by his adviser for slow payment of debts, he or she must resist the temptation to talk about pots calling kettles black.

Whether or not the merger goes ahead, KPMG and E&Y senior partners Colin Sharman and Nick Land should invest in a couple of dirty raincoats and two smelly kippers and sit in some blue-chip receptions until a cheque is produced. The good news is that they are both as bad as each other. If you combine WIP and debtors, the debtor-days are almost identical.

The cashflow provides some interesting contrast to the way the two firms are currently managing. E&Y, despite being the smaller firm, had cash outflows on capital expenditure of #16.5m, compared with #13.4m for KPMG.

The other figure which is hard to ignore in the cashflow is distribution to partners: KPMG’s was a thumping #152m, up 27% on last year’s #120m, and E&Y was positively modest in comparison shelling out a mere #89.3m, up 20% on 1996.

At the end of the day, unlike quoted companies which have to keep outside shareholders – notably institutional investors – happy, E&Y and KPMG have to financially satisfy their partners and staff. In 1997, E&Y employed, on average, 6,198 (6,157 in 1996) of which 963 (988 in 1996) were support staff. Nearly one in four were auditors (sorry, business assurance staff). They cost the partners #208m in salaries, social security costs and pensions, which is an average package of #33,500.

The KPMG prelims don’t reveal staff numbers, but in 1996 the 7,949 staff averaged over #1,000 more at #34,700. The 1996 figure for E&Y was a shade under #31,000. So there’s a fair bit to talk about in the combined audit rooms and tax offices.

And what about the partners? Partners pay falls into two areas: remuneration and pensions. In 1997, E&Y paid a total of #80.5m in pay, and #18.6m in pensions. Pay and rations leapt up by a third in the year. E&Y said the average partner earned #203,000 (1996 – #154,000), while the per partner pension contribution alone in 1997 stood at #45,000. In other words a partner’s pension amounted to 34% more than the average staff earned in total.

Still, that’s the price of bearing the strain of unlimited liability.

The spread of partnership earnings is wide. Of the 427 partners, there is a relatively even spread ranging from #100,000 to #300,000 (remuneration only). KPMG’s 1996 figures seem to indicate more modest partner rewards.

In 1996, E&Y’s 397 partners shared #74.4m (average #187,000) while KPMG’s more numerous partners – 574 in all – pulled out #91.2m, an average of #159,000, around #28,000 shy of the E&Y partners.

But maybe the 1997 cashflow figure to partners indicates some catching up. KPMG’s partner earnings were much more bunched than E&Y’s with nearly 50% of partners falling into the #75,000 to #125,000 earning brackets (remuneration only), which seems positively frugal. It’s all food for thought when the FD is discussing next year’s fee levels – and you can bet it has taken up more than a minute or two of the merger talks.

The reports used were E&Y’s 1997 report and accounts, KPMG’s annual report 1996 and preliminary announcement of results 1997. KPMG’s full report for 1997 is due any day. Both were UK figures only.

Peter Williams is a freelance jounalist.