Fewer firms but bigger fees

The decline in the number of small and medium-sized practices (SMPs) in the UK may have set in before the pandemic this year, but now SMPs face an even tougher future.

While Covid-19 will undoubtedly have hastened this contraction, the next 12 months will be crucial as clients struggle with a potential second wave of the pandemic and a new economic and working environment. Many SMPs will also have already been facing difficulties prior to the pandemic, as technology investments and new entrants into the market squeeze existing practices.

While some firms may have seized the opportunities on offer, many others will have seen their partners sell up, retire, merge the firm with another outfit or simply cease to practise. In the UK, there are now 35,520 accounting and audit firms. According to the Office of National Statistics (ONS), the number of firms grew by an average of 1,212 a year between 2011 and 2017 (a total gain of 7,270 over the period). Since then, though, the UK lost nearly 500 firms in the two years to 2019.

Mixed fortunes

However, it is a picture of mixed fortunes. According to a study by cashflow software provider Float, the number of firms with a turnover of less than £100,000 fell by 5.4% between 2017 and 2019, from 21,020 to 19,890. But the number of accountancy firms with a turnover of more than £100,000 rose by 4.3% in the same period, from 14,985 to 15,630.

Float also reveals that the partnership model has fallen out of favour over the past decade. In 2010, 3,125 accountancy firms were partnerships, but by 2019 this number had nearly halved to 1,745, equivalent to just 5% of all UK firms. And the number of sole traders recognised by the ONS also dropped by nearly 3,000 over the same period, from 7,980 to 5,150.

‘Accounting firms have demonstrated their immense value during the Covid-19 pandemic, helping struggling businesses stay afloat and informing them of their financial options,’ says Colin Hewitt, chief executive of Float. ‘Which is why many will be concerned to see the number of UK accounting firms in decline.’

But he adds that lack of growth does not necessarily mean the industry is in poor health. ‘We witnessed a great accounting boom in the UK this decade, with it being easier than ever to set up and run a new firm,’ he says. ‘This appears to have tailed off, and increased market consolidation has contributed to a net reduction in firms.’

Multiple pressures

Industry veteran Philip Shohet, who advises firms on strategy, believes the next 12 months will be ‘telling’ for small firms. ‘Going forward, SMPs will have smaller clients, who will be struggling as well, and the client base will affect the practice. If a client can’t survive, how does the practice survive? For the clients that are in survival mode, how does the small two-partner practice give them the advice they need?’

In other words, clients will need more than just solid technical skills from their accountants to make it through the post-pandemic period. A firm that is heavily exposed to a sector such as retail or hospitality could find that preparing the financial statements is low down on their clients’ list of priorities.

But there are other factors at work here that were in play before the pandemic and had already been forcing SMPs to change their business model. As Shohet points out, changes in audit regulations have been ‘absolutely catastrophic’ for smaller firms, forcing many to retreat altogether from this area of the market.

Bookkeeping boom

Greater automation is also disrupting the sector. Those firms that have not invested in technology will not be cost-effective and competitive at simple bookkeeping or tax compliance work. New entrants are increasing the competitive pressures, while many SMPs don’t have the capital to invest in new technology.

As a result, as Float observes, the bookkeeping segment is still enjoying a period of tremendous growth. According to the ONS, the number of bookkeepers in the UK rose by 395 over the same 2017–19 period as accountancy firm numbers fell back. There are now 6,640 bookkeeping enterprises in the UK, a 113% rise on the number in 2010 (3,110).

But Shohet believes accountants need to offer much more than bookkeeping and tax compliance expertise. What clients want from their accountancy firm is business acumen. If existing partners don’t already possess this in depth, they will need to bring in external expertise. Diversification is also prevalent in the sector, with many SMPs now offering financial and wealth management services.

The fall in SMP numbers is in part due to the re-emergence of consolidators (groups that buy up practices and make back-office efficiencies). ‘You can get a good price for your firm so long as it is presented well,’ Shohet says. ‘This will also benefit clients, who will get access to a wider suite of services.’

And a wide spectrum of services is exactly what SMPs’ clients will be looking for above all else in the immediate future as they grapple with the challenges ahead.