Evaluating the financial performance of Deloitte LLP

All of the research topics are appealing although challenging but it was apparent that I have to choose the topic that meets the research requirements such as accessibility and quality of information and clear understandability of what is required in a particular topic. After spending a lot of time in selecting the best topic for me, I came to the conclusion that I should go for topic no. 8 “The business and financial performance of an organisation over a three year period”. The rationales behind choosing this topic are:

I have been trained in ACCA studies as how to evaluate an organisation’s performance using ratio analysis and other techniques. The research on this topic will help me to consolidate my knowledge and put me in a strong position to carry out this study.

Accessibility and the quality of the information required for this topic was much easy to obtain as compared to other topics. To carry out the business and financial evaluation I need the audited annual reports and other strategic information of an organization which should be relevant, reliable and readily available thus enhancing the quality of this research project.

Part of the accountant’s role is to help companies in analysing and interpreting the financial performance and position of the organisation and advise the client in which particular areas they are performing well or where they need improvements and to answer such questions as to why the particular ratios are boosting or declining. Without any doubt, this research will help me in my practical life as an accountant.

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Reasons for choosing the organization:

It was clear in my mind from beginning that I should undertake the research on an accounting firm because it is within my profession. I made my mind that I will pick any one of the big four i.e. PwC (PricewaterhouseCoopers), KPMG, Ernst & Young and Deloitte Touche Tomatshu. As these firms are LLPs (Limited liability partnerships) I faced the difficulty of the amount of information available because LLPs are not under the same extent of public domain as compared to public listed companies which publish substantial amount of information and are subject to regulations regarding the disclosure of the information. First I thought that I should carry out research on PwC as it ranks number 1 in big 4s but when I started searching on the internet about big 4s then I found much information about Deloitte and even their website and annual reports were much comprehensive so I decided to choose Deloitte LLP. The main reasons for choosing Deloitte LLP were:

It is one of the largest professional services firms ranking 3rd (Vault Accounting firm ranking 2008). This ranking is based on the sales revenue generated by the firm and other factors such as working life etc. I wanted to carry out the research on a top ranked firm as there is a lot to learn from successful firms.

Deloitte LLP is the market leader in the professional services industry and a very reputable organisation. Undertaking the research on this firm will help me explore why this firm is flourishing. Moreover, after finishing my ACCA qualification I would like to work in an accounting firm and doing the research on Deloitte LLP will help me understand the nature, market, culture and governance of the accounting firms.

Project Objective

The objective of this research project is to evaluate the business and financial performance of Deloitte LLP with last years and with its competitors PwC for the years ended 31st May 2006, 2007 and 2008.

The Research Questions

I identified the research questions which will help me achieve the project objective. Focusing on these questions will help me keep the research on track and to the point. These research questions are:

What are the firm’s objectives and what strategy has been adopted to achieve them?

How did the firm perform in terms of profitability and what are the main factors affecting its performance?

What are the trends in the liquidity position and is the cash management of the firm effective?

Is the organisation growing? If so, what sources of finance does it use and how does it impact on their gearing levels?

How has the organisation been influenced by the current economic downturn and how will it impact on the next year performance?

The Research Design

To evaluate the business performance of the firm different modules such as mission analysis, Porter’s five forces and SWOT analysis have been used to analyse the industry and evaluate firm’s strength, weaknesses, threats and opportunities. To interpret the financial health of the organization, ratios have been calculated for three years which are then used as a basis for historical and competitor benchmarking. These techniques include comparing the financial performance of the organization with its prior years and those of its competitors. Focusing on financial ratios are not enough to come up with the whole picture so other non-financial performance indicators have been used as well. Trend analysis has been used to identify the changes from year to year. These analytical techniques will assist to analyse, interpret and evaluate the organisation’s performance and support to come up with the appropriate conclusions.

Part 2 Information gathering

To evaluate the business and financial performance of Deloitte LLP, I require reliable, qualitative, quantitative and sufficient information that not only focuses on financial and business perspective of the organisation but also industry specific knowledge such as is the market growing or declining, who are the market leaders and what is their strategy. During the information gathering stage, I have not just collected the information about the firm but also kept an eye on its competitor’s activities. This parallel approach helps me in benchmarking exercise.

Types of research methods:

Based on this, two key sources of information were used i.e. primary and secondary sources. Both of these methods have their own pros and cons. Primary research is more reliable, relevant and is tailored to the research needs. However, this approach is very time consuming and expensive and usually not available as compared to secondary sources which are readily available and easy to access but may not meet research questions and is less reliable.

During the information gathering stage, less field research has been undertaken and contacted the firm only if any particular information is not available from the secondary sources. Primary research was done for one particular issue that arose during the research and that was to understand the legal structure of Deloitte Touche Tohmatsu and its member firms. The only method used for this primary research was emails. However, most of the information required for this research was available from the secondary sources and have been listed below:

The firm’s website:

The organization’s website www.deloitte.com provided me with much of the information about the firm’s history, their vision and strategy, leadership, the services in which they are specialized, the industries to which it provides services and the latest news about the firm’s activities. However, to critically evaluate the organization’s performance I need to seek more information outside the company’s website as every company is tempted to give a positive image of their organization so I went ahead and used its competitor’s website as well and other external media.

Annual reports:

The annual reports of Deloitte LLP are the vital source of information for this research and are easily accessible from the firm’s website. The information obtained from the annual reports is used in calculating and interpreting the financial ratios. The financial statements also include last year performance which helped me a lot in analyzing the trends in performance and moreover it includes the graphs and charts that assisted me a lot to understand it in less time. However, there is too much information in the annual reports so it’s easy to get overwhelmed.

Books:

To get the initial guide on how to start the project I have read “BSc (Hons) in applied accounting” published by BBP learning media. The book guided me on how to approach this project in a more formal and organised way and facilitated me in every stage of the research from choosing the research topic to writing the skills and learning statement. Other books that I used for the project are drawn from ACCA syllabus. These books are used with the aim to refresh my mind with what I have learnt in ACCA studies.

Electronic researches:

A vast majority of information is available in the electronic media which benefited a lot during the research stage. The websites are used to get the latest news and other related information. These websites not only provided me the information about Deloitte LLP but also that of its competitors and market.

Regulatory body website:

The Professional oversight board is a UK regulatory body which specializes in auditing, accounting and oversights the accounting profession. The website used in this research was www.frc.org.uk. The website contains reports about the accountancy market and key facts and trends.

Part 3 The analysis, results & conclusions:

The firm:

Deloitte LLP is the UK member firm of Deloitte Touche Tohmatsu (DTT), a Swiss Vereinwhose member firms are a network of legally separate and independent entities. Swiss Vereinis the structure that is recognised under the current composition of Swiss law where organizations are established as Limited liability business. Swiss Vereinorganisations are characterised with a corporate organisation that is decentralised. (Swiss Verein). DTT does not provide services to clients, or direct, manage or control its member firms. This decentralised structure allows DTT organisation to establish policies; member firms apply these policies in quality assurance processes that comply with the local regulatory, legislative and professional requirements. (Annual report 2008)

Business Analysis:

The Mission & strategy:

The firm’s mission is to be recognised as the best professional service provider and its slogan is “To help clients and people excel”. The firm achieves this by identifying and focusing on the needs of clients, providing the high standard professional services and by investing in their people. (Mission statement).

“Our mission makes reference to ‘our people’, as management recognises their importance in achieving our vision,” (Deloitte Orla Graham, HR manager). Deloitte aim’s to be the number one firm for career and personal development and they have a clear strategy to achieve this. Its strategy involves providing continuous training and development opportunities to their staff to ensure that the services provided to the clients are up to the highest standard of quality and complies with all the regulations.In the past, Deloitte has focused on scale and global coverage but now it is focusing on the standard of excellence (Deloitte – Vision & strategy). In 2003, Deloitte was recognised as the UK’s fastest growing professional firm and in the last few years the firm was acknowledged because they have broader range of skills and highest quality services showing their proficiency. Their strategy focuses on four elements:

Broader range of capabilities than its competitors

Focus on quality

The environment where people can develop and excel

A culture that emphasis teaming and high performance (Annual report 2008)

The Services offered by the firm:

The firm specialises in four services which are Audit, Consultancy, Tax and Corporate finance. These services are provided in different industries such as non-profit organisations, real estate, sports business group, manufacturing, tourism, hospitality & leisure, technology, media & communication etc.

Porter’s five forces and market analysis:

Porter five forces is the framework for industry analysis that identifies the five factors which influence the performance and position within the given market.

Although there are several thousand firms in the market but the audit and consultancy market is highly concentrated and dominated by the big fours in the UK and globally. Deloitte & touche, KPMG, PwC and Ernst and young audit all of the FTSE 100 companies and represent 99% of the audit fees in the FTSE 350 showing that the market is much concentrated by the big four accountancy firms.. There are two segments of the market. The first one is FTSE 100 companies and FTSE 250 which are covered by the big four and the other segment is the smaller listed companies which are serviced by both the Big four and mid-tier firms (Oxera Report- April 2006). Threats of new entrants in the market are low because of high costs, long payback period and significant business risk. Threats of substitute within accountancy market are also very low because audit, tax and other accounting services are required by law and regulations.

The accountancy market in the UK is still growing, but at a much slower rate than in the late 1990s (PRlog Press release – 11 April 2007)

The main clients of big four accounting firms are the top ranked companies listed on the stock exchange and the stakeholders (lenders, shareholders etc) of these FTSE companies require them to appoint big four accounting firms for professional services because they have the expertise and technical capability to deal with the complexity of these companies which restricts the “buyer power” within the audit market. As seen, these companies have effectively no choice of auditors other than Big 4s as large companies do not favor the mid-tier firms

There is a strong competition in the market particularly between big 4s. Tendering process is been used to gain new clients. However, these firms may find it difficult to offer clients’ different services to gain competitive advantage as most of the accountancy services are standardized.

Switching rates in the market are low- around 4% per year on average for listed companies. Few companies have an explicit policy of switching auditors at regular intervals and competitive tendering does not occur frequently -nearly 75% of the companies surveyed tender once every five years or less, and more than 70% of the FTSE companies have not held competitive tendering in the last 15 years. Organizing tenders, and then changing auditors are costly to both the accounting firms and companies. (Oxera Report- April 2006)

SWOT Analysis:

The SWOT analysis of Deloitte has been conducted solely with the aim of understanding and evaluating the strengths, weaknesses, opportunities and threats and is detailed below:

Strengths:

Reputation & Brand of the firm – Deloitte has been enjoying good reputation and has brand awareness in the market. This reputation and brand are the intangible unique resources and facilitate the firm to attract multinational clients, this helps them to charge premium for the quality services provided and thus increases revenue and profitability.

Skilled staff and effective leadership – As the firm is in service industry, keeping an effective management team is a key for its success. The senior management team has been drawn from wide range of sources and helps the firm to have diversity in the skills and this could be evidenced in Sunday times, where Deloitte has been listed in the Best big companies to work and also have been named as the No. 1 graduate employer in finance and professional services in the National Graduate Recruitment Awards, (Award winners) taking the award from PwC which has held top spot for the past three years. These highly qualified and experienced staff flourishes the firm to provide the clients with best quality services in a professional manner. .

Quality Culture – The firm has a high quality and high performance culture. This is achieved by embedding quality into people via learning, training and awarding employees with high performance through competitive reward strategy. This facilitates the firm to offer quality services to its clients which results in high customer satisfaction rate.

Weaknesses:

The structure – The firm operates as a limited liability partnership. Under this structure, partners have limited liability and are not responsible for the misconduct of the other partners but due to this structure the firm may find it difficult to raise finance other than relying on partners and bank loans.

Opportunities:

During the current economic downturn, most of the companies are reviewing for cash flow management, risk management policies to ensure there are appropriate procedures in place to avoid any losses, and optimising costs etc. This brings an opportunity for Deloitte to enhance its business and risk management services to advise on the risk practices adopted by the clients.

Moreover, during the recession a lot of companies are filing for bankruptcies which may also result in increase in consultancy service demand as clients may be looking for administration and restructuring advice. Deloitte is utilising this opportunity as this could be evidenced when Louise Brittain (UK’s leading insolvency practitioner) joined the firm in its reorganisation service practice and will aid the firm in getting high profile appointments. ( Deloitte Press release 12 Feb 2009) Deloitte has been appointed as administrators of Land of leather (furniture store retailer), Woolworth Plc (the high street retailer), Entertainment UK (UK’s leading distributor of entertainment products) showing that the firm is well equipped to meet the opportunities. However, these opportunities are short term in nature and the firm needs to identify other long term opportunities from the market that exploit their strengths.

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Threats:

As accountancy is not a recession proof profession, the current economic crisis has brought threats for Deloitte and may have serious consequences. As Deloitte LLP provides audit services to clients that involves giving appropriate opinion on the truth and fairness of the financial statements and on the going concern assumption (whether the clients will be in existence in the foreseeable future). During this financial crisis, accounting firms need to have prudent approach in carrying out the audits of clients as during the recession the clients may be tempted to use dubious accounting practice to retain the shareholder’s confidence. Also, auditors are under pressure to carry out detailed testing whether the client is able to borrow money from its bank due to insufficient borrowing facilities in the economy. Inappropriate opinion given on the future existence of the client may put auditors in the risk of being sued for negligence and may result in fines and penalties.

Moreover, many companies have filed for bankruptcies which will reduce the client base for Deloitte and will impact on the performance.

Non financial performance evaluation:

Staff satisfaction:

One of the critical success factors for Deloitte is the skilled and highly motivated staff. These people are the unique assets and will underpin the performance of the firm. The survey conducted by the “The Workplace Engagement Specialist” shows high level of pride and job satisfaction among staff with 76% staff proud to work for the firm and 72% find their job stimulating. Deloitte spends about £12m a year on developing its employees and has a dedicated team of trainers who can help their staff and every staff member has a career development adviser. (The Workplace Engagement Specialist)

Quality:

Quality is the core competence of Deloitte and a key factor in retaining the existing clients and attracting the new appointments. Deloitte has a high performance culture where providing the high quality service is paramount which helps the firm to gain competitive advantage. Their “Quality Agenda” focuses on three elements; clients, infrastructure and people. The firm emphasises in understanding the client’s expectations and this is achieved by working closely with clients, embedding the quality into their people and infrastructure which focuses on effective leadership, internal training programs, professional standards and review assessments. (Annual report).

New partners / talent:

Recruiting the required level of staff is as important as maintaining the skilled staff. It is essential for the firm to bring new talent. The firm is seen as continuously investing in people; in 2007, there were 11,000 partners and member staff working across UK. In 2008, this number increased to 12,000. Deloitte has high staff turnover rate of 17% (Sunday times) as compared with its competitor PwC which was 13% (PwC Annual Report 2008) indicating staff is less satisfied with the firm comparatively and leaving at a higher rate than PwC even though PwC has more number of staff than Deloitte still their staff turnover ratio is low.

Financial performance evaluation using Ratio analyses:

Ratio analysis is the widely used technique in evaluating the organsation`s financial performance because this method helps to summarise the results in a simple way and moreover inter firm comparison helps to conclude how is the organisation performing in relation to industry and other organisations within the market and encourages to think out side the box.

The main indicators used to evaluate the firm’s performance are sales growth, profitability, liquidity measures and financing arrangements and are discussed below.

Sales Trend Analysis:

The revenue of the firm is constantly increasing. Gross revenue increased by 11.5% in the year ended 31st May 2008 as benchmarked with last year exceeding the £2000m target to £2,010m. The competitor – PwC’s revenue was £ 2,244m in 2008 which was a 7% increase in revenue as compared to last year showing that Deloitte is growing rapidly as compared to its competitors. The Deloitte’s revenue and that of its competitor PwC has been shown in the following graph comparing the revenue from year to year.

The group is managed by the matrix structure which incorporates both service lines and the nature of the market to which services are supplied (Annual Report 2008).The sales revenue analysed by service line/segment has been shown below.

Interpretation:

Revenue analysis 2006:

Overall, turnover grew by 15% to £1,559m and 32%, 27%, 24% and 17% of the revenue was contributed by audit, tax, consultancy and corporate finance respectively. The consultancy division performed very well in 2006 as the division’s revenue grew by 22% and this growth has led the Deloitte being recognized as the market’s leading business consultancy service provider. In 2006, the audit division contributed the substantial amount of revenue and increased by 17.2% during the year as the audit market share in FTSE 100 and FTSE 250 continues to grow.

Revenue analysis 2007:

Revenue grew by 15.6% to £1,802m when PwC’s revenue grew by only 6% to £2,107m indicating that Deloitte is growing at the faster rate than its competitors. The reason for this growth was the strong market, reputation and talented staff which have given Deloitte the opportunity to gain new clients and win many new assignments from existing clients all across business segments and industries according to Chief executive. In 2007, the firm’s revenue grew by higher rate than its competitors which was 6.1% for PwC LLP and 10.5% for KPMG LLP. Once again, the significant amount of revenue was contributed by the audit division. The consultancy division is also growing but at slow rate as compared to last year. Overall, all the division’s revenue grew and ultimately resulted in a healthy progressive year.

Revenue analysis 2008:

In 2008, the firm exceeded its £2b target and reported a strong growth of 11.5% given the complex markets. Deloitte is seen as having a superior performance than its competitors PwC as their revenue only grew by 7%. On this excellent performance, Deloitte’s CEO claimed that they have surpassed their competitor PwC in terms of standing in the market place but PwC’s new chairman, Ian Powell denied Deloitte’s claims that it has overhauled its rivals in terms of reputation saying it was ‘pretty difficult to prove. (Accountancy age -14 Aug 2008)

The reason for this growth is the Deloitte brand, the experienced professional staff and management’s efforts to identify and capture high growth opportunities. All the divisions are growing but at slower rate as compared to last year. The reason for this could be the UK economy shrinking which has restricted many business opportunities for organisations which certainty impacts consultancy and corporate finance divisions. Moreover, in this economic crisis, clients are forced to reduce costs so they may have appointed mid-tier firms which may have influenced Deloitte`s performance. However, audit division grew by 11% and is now the co-leader in the share of FTSE 250 audits. (Annual report 2008).

Profitability ratios:

Profitability ratios measure the performance of the management and the return they are generating from the assets invested in the business by the partners.

Gross profit margin:

Gross profit margin measures the firm’s profitability from its operations and represents the relationship between sales revenue and directly related costs in providing services to clients and is calculated as:

Gross profit margin = Gross profit / Sales revenue x 100

The gross profit margin of year ended 2006, 2007 and 2008 are 49%, 49% and 50% respectively showing that the firm’s gross profit is increasing. As Deloitte is in service industry, the only directly related costs are staff costs and expenses & disbursements on client assignments and gross profit is calculated as the difference between the sales revenue and these directly related costs. The firm gross margin is nearly constant in the last three years. This shows that the firm is very efficient in controlling its costs in relation to its sales and in a better position to cover its other costs such as interest, tax etc. The staff costs are the major cost in providing services and represent 36.3%, 36.8% and 35.5% of sales revenue in the last three years, which are nearly constant.

Net profit margin:

It is the ratio that measures the overall performance of the firm after all the expenses have been deducted such as interest and tax and is calculated as:

Net profit margin = Profit after interest and tax / Sales revenue x 100

There was an upward trend in the net profit margin in the last three years and net profit margin was 29%, 31% and 32% in 2006, 2007 and 2008 respectively. As seen in the chart, where PwC’s net profit margin is declining from 35% in 2006 to 33.3% in 2007 and 30% in 2008 Deloitte’s net profit margin is increasing. However, where the sales revenue increased by 12% in 2008 net profit margin only increased by 3% which shows that although the firm is growing in terms of revenue and profitability but not in a consistent way i.e. if sales are growing then net profits should also increase by the same proportion (although it is very ideal situation) but it is not the case with the firm. Overall, the firm’s net profit margin is increasing. The net profit margin of Deloitte was higher as compared to competitor’s net profit margin which was 30% for PwC and 20.40% for KPMG in 2008. Even though the competitor’s revenue and net profit was higher but the net profit margin ratio was low as compared to Deloitte’s indicating that the firm is earning high profitability rate than its competitors.

Profit per partner:

The profit per partner of Deloitte and PwC LLP is shown below:

The profit per partner calculated above represents an average figure but partners share profits based upon the evaluation and the contribution of each individual partner to achieve the strategic objectives of the firm. Although the firm’s average number of partners also increased from 641 to 672 members in 2008 but it didn’t deteriorate the average profit per partner because of rising profits. As seen in the chart, where Deloitte’s average profit per partner is increasing PwC’s profit per partner is decreasing. The profit per partner is consistently increasing which will ultimately results in partner’s more confidence in the firm’s performance.

Liquidity ratios and Cash flow management:

For a successful firm, making a healthy profit is not enough; the firm must be effective in cash management because cash is considered as the lifeblood of the organisation. Profitability measures are subject to criticism of manipulation and short termism but cash/liquidity measures are hard to manipulate and gives an indication of the firm’s solvency position. The liquidity ratios with their interpretation are given below:

Current ratio

Current ratio measures the firm’s ability to cover its current liabilities (short term debts and obligations) by its current assets. Higher current ratio indicates that the firm is liquid. The ideal ratio is considered to be 2:1 i.e. the organization has twice assets to cover its current liabilities but it differs from industry to industry.

Current ratio is calculated as = Current assets / Current liabilities

The firm’s liquidity position is steadily improving. In 2006, the firm has a cash balance of £10m and an overdraft of £22m showing a net deficit of £12m but the firm has other liquid assets to cover its current liabilities thus a current ratio of 1.7. This overdraft had been repaid in the next year with the cash & cash equivalents of £51m showing a healthy cash position with a current ratio of 1.9. In 2008, the company has a strong liquidity position when it accomplished the ultimate benchmark level of 2:1 which was in line with PwC’s current ratio of 2:1 and was higher than KPMG’s which was 1.5:1. The reason for this is that the firm’s current assets grew by 19% while current liabilities increased by just 6% in 2008 and is moving towards more stable position.

Receivables Day Ratio:

Receivables day measures the average number of days the receivables take to pay for the services provided. The firm has an effective working capital management if the receivables pay within the credit period given to them as the firm will also be able to meet its short term obligations as they fall due.

Receivables day ratio = Receivables / Credit sales x 365

The receivables day ratio has been constantly improving from 116 days in 2006 to 104 days in 2007 and 101 days in 2008 showing that the firm is recovering its money back from receivables more efficiently. However, the receivables collection period of the firm is very high as the competitor’s collection period which is in the range of 80-90 days indicating that Deloitte is offering its clients extended credit terms to boost revenue. Although the firm’s sales revenue is increasing with an increase in receivables yet the firm managed to keeps the receivables collection period improving.

Operating cash flow ratio (OCF):

OCF ratio measures the liquidity position. Using cash flow as opposed to income or profit is a better measure as it expresses the firm’s ability to pay its short term debt from the cash generated from its operations. If the ratio is less than 1, it indicates that the firm is not raising enough cash from its operations to meet its short term obligations and may indicate the need to raise additional funds from other sources to pay its debts on time