How to run FDD on a professional services firm: WIP and over-time revenue, utilisation, partner remuneration normalisation, client and staff concentration, and WIP-heavy working capital.
A professional services firm - a consultancy, law firm, engineering practice, recruitment or accountancy business - has almost no assets you can touch. Its value walks out of the door every evening and, ideally, walks back in the next morning. There is no plant, little inventory, and the "product" is billable time. That changes financial due diligence fundamentally. The three questions that decide the deal are: when is revenue really earned, what does the workforce actually cost, and how much of the reported profit is simply owner pay dressed up as EBITDA? Get those right and a people business becomes analysable. Get them wrong and you will pay an EBITDA multiple for what is essentially the founders' salaries.
Most of a general Quality of Earnings exercise assumes a business with a product, a cost of goods line and a balance sheet full of stuff. A professional services firm has none of that. Instead:
In a professional services deal, the QoE and the working-capital analysis are really one workstream, because both hinge on how work-in-progress is measured.
This is the analytical core. Professional services revenue is typically recognised over time as the work is performed (IFRS 15's over-time criteria are usually met because the client controls or benefits from the work as it is done, or the asset has no alternative use and the firm has an enforceable right to payment). That means revenue depends on an estimate of progress - and estimates can be pushed.
Three balance-sheet items carry the risk:
What you test:
This is a specialised cousin of the revenue quality analysis you would run on any target - the difference is that here the revenue asset is judgemental to its core.
On a services firm, WIP is where optimism lives. Every hour recorded against a job is potential revenue - but only if the client will actually pay for it. Ask what proportion of recorded WIP converts to cash within 90 days. If nobody can answer, you have found your first workstream.
The engine of a professional services firm is utilisation (also called chargeability): the proportion of a fee-earner's available hours that are billed to clients. It is the single most important operational metric, because at a given charge rate and salary, utilisation determines profitability almost on its own.
You want to understand whether recent EBITDA rests on an unsustainably high utilisation (a team being run hot, which burns people out and drives attrition) or has headroom. A firm reporting record profit on 85% utilisation is not a growth story - it is a business with no capacity buffer and a looming staffing bill. Model what happens to margin at a normalised utilisation, and treat any recent spike with suspicion.
In a services firm, staff cost is the cost of goods sold. It typically runs to 55–70% of revenue, so small movements swing EBITDA dramatically. Read it carefully:
Any adjustment to normalise staff cost - for instance, removing a one-off retention bonus or correcting an under-accrued commission scheme - flows straight into EBITDA adjustments.
Here is the adjustment that defines professional services diligence. In an owner-managed firm, the partners or directors are simultaneously the owners (taking profit) and the fee-earners (doing chargeable work). Their total reward is often a mix of a modest salary, large dividends and a share of profit - and none of it is set at a market rate. Before you can talk about a defensible EBITDA, you must normalise owner remuneration to a market cost of employing equivalent fee-earners.
The logic: a buyer purchasing the firm will still need those people to do the work (or replacements), and will have to pay them a market salary. So you replace the owners' actual, non-market remuneration with the fair market cost of their role. This can move EBITDA in either direction - up if owners over-pay themselves, down if they under-pay to inflate reported profit ahead of a sale.
Two founding partners run a consultancy. They pay themselves small salaries and extract the rest as dividend. The market rate to employ two senior fee-earning directors of their calibre is, say, £180k each. Here is the normalisation.
| Line | Reported (£000) | Adjustment (£000) | Adjusted (£000) | Note |
|---|---|---|---|---|
| Revenue | 6,500 | - | 6,500 | |
| Staff cost (ex-partners) | (3,400) | - | (3,400) | |
| Partner salaries (as paid) | (120) | - | (120) | 2 × £60k |
| Other operating costs | (1,600) | - | (1,600) | |
| Reported EBITDA | 1,380 | Before dividends | ||
| Normalise partner cost to market | - | (240) | (240) | 2 × (£180k − £60k) |
| Remove personal/non-business costs | - | 90 | 90 | Owner's car, travel add-back |
| WIP over-recognition (cut-off) | - | (150) | (150) | Optimistic completion estimate |
| Adjusted EBITDA | 1,380 | (300) | 1,080 | Basis for the multiple |
The takeaway: reported EBITDA of £1.38m becomes a defensible £1.08m once the partners are costed at market and WIP cut-off is corrected - a 22% haircut. At a 6x multiple that is £1.8m of enterprise value that should never have been in the price. This normalisation is the beating heart of a services QoE, and it feeds directly into the equity-to-enterprise-value bridge that turns headline value into what the seller actually receives. In a partner-heavy structure, the mechanics also interact closely with the deal structure and SPA - buyers routinely tie earn-outs and retention packages to the very people whose pay you just normalised.
Professional services firms carry a double concentration risk, and both belong in the report.
Both threads connect to the general customer concentration framework, but in services you must always ask the second question: does the client relationship belong to the firm, or to a person who could leave?
A services firm's working capital is dominated by unbilled WIP and trade debtors, offset by relatively small payables (few suppliers, mostly people who are paid monthly). Two metrics matter:
| Working capital component | Value (£000) | Days | Comment |
|---|---|---|---|
| Work in progress | 900 | 51 | Age it - old WIP may not convert |
| Trade debtors | 1,050 | 59 | Watch overdue balances |
| Deferred income (retainers billed ahead) | (300) | (17) | Funds the firm in advance |
| Trade & other payables | (250) | (14) | Small - mostly staff-related |
| Net working capital / lock-up | 1,400 | 79 | Basis for the peg |
Setting the working capital peg on a services firm is contentious precisely because WIP valuation is judgemental - an inflated WIP balance at completion hands cash to the seller. Build a normalised, recoverable WIP figure and use a monthly average, exactly as you would in any rigorous net working capital analysis, and be ready to defend it against the seller's advisers.
Professional services comes up constantly because it forces the candidate to think about people economics rather than product margins. A common prompt: "You're diligencing a founder-owned consultancy reporting £2m EBITDA. What's your first move?"
"My first move is to normalise partner remuneration, because in a founder-owned firm the £2m is almost certainly overstated - the owners are the fee-earners and they're paid on a tax-efficient basis, not a market one. I'd cost each working partner at the market salary a buyer would have to pay to keep the work getting done, and adjust EBITDA for the difference. In parallel I'd dig into revenue recognition: this is over-time revenue driven by WIP and percentage-of-completion estimates, so I'd age the WIP, look at historical write-off rates and test the completion assumptions on fixed-fee jobs for any cut-off flattering the period. Then utilisation - I'd check whether the margin depends on an unsustainably high chargeability that's really burning the team out, and model a normalised rate. On concentration I'd quantify revenue by client and by originating partner, and read the non-compete and client contracts, because in services the relationships can walk out with a person. Finally working capital: WIP and debtor lock-up drive cash, and I'd set the peg on recoverable, normalised WIP rather than the book figure. My deliverable is an adjusted EBITDA after market-rate partner cost and WIP cut-off, plus a clear read on how much of the business is really two or three key people."
That answer leads with the partner adjustment, which is exactly what an interviewer wants to hear first. To rehearse this kind of structured, sector-aware response, the TS interview preparation plan is the fastest route.
A professional services firm is a bet on people, priced through a P&L that mixes the owners' pay with the company's profit and measures its main revenue asset by estimate. The analyst's craft is to separate the three: cost the fee-earning owners at what a buyer would really pay, value WIP at what will actually be collected, and stress-test the utilisation that produced the margin. Do that and you hand the buyer an EBITDA that survives the owners' departure. In this sector you are not buying a business so much as renting the loyalty of the people inside it - so price the people honestly, and never pay a product multiple for a payroll.
The Transaction Services Interview Programme (€119.99, one-time) includes a professional-services module on partner remuneration normalisation, WIP and over-time revenue recognition, utilisation analysis and lock-up-driven working capital, with worked normalisation exercises and interview drills. Enrol today.
Hundreds of candidates prepared their interviews with this programme. Those who landed the role have one thing in common: they worked the cases before walking into the room.
