Once upon a time when my ‘past self’ first considered a legal career, business and profits did not spring to mind.
A lot of us forget the fact that law firms are first and foremost businesses which exist to make money. The reason firms are formed are to work at a profit for the partners, and our job as solicitors is to generate income to this end. All of the activities of a law firm and its business development strategy are driven towards increasing profitability.
In the current market there is a wide variation in profitability across different firms and areas of law. There is a good news though, as economic recovery has truly set in and law firm performance has improved since the credit crunch of 2008. Firms appear to have maintained profitability levels and are now recovering. Despite the challenges facing firms, many have adapted their business models to maximise their profitability in the changing market.
How do firms measure profitability?
The complex economics are beyond the scope of what you are expected to know but here are some basics to help you gain an understanding:
- Turnover = fee income (the money that comes into the business)
- Profit = turnover minus expenditure (cost of overheads)
- Profit per equity partner (PEP) = total profit divided by the number of equity partners and the most common measure of profitability
- Gearing (or leverage) = the ratio of fee-earners (paralegals, solicitors etc) to the number of equity partners. As a general trend, it is difficult to achieve good profitability if the majority of lawyers are equity partners. There needs to be a good level of gearing but this will depend on the area of law. Conveyancing and personal injury will usually be highly-geared areas with lots of low-level fee-earners, whereas more technical areas such as tax and corporate will be less geared: that is, partner-heavy. Firms should consider hiring more staff to increase gearing and hopefully profitability.
As a general rule, fee-earners are expected to bill three times their salary – this will cover their own pay, their contribution to the firm’s overheads and the partners’ profits.
What influences profitability?
Profitability can be influenced by the quality of work (technical work will be more profitable), a firm’s ability to retain clients and a constant flow of instruction, the firm’s financial structure and monitoring of performance and ability to cut costs.
Costs can be fixed (salaries, rent) and variable (insurance, IT systems, training, and utilities) and firms must be mindful of controlling them. Often firms will have financial coordinators to deal with budgeting and cost management.
How to maximise profitability
Firms analyse the profits of all of their departments to understand which services are profitable. They will often monitor performance and analyse fees earned per fee-earner to measure profitability.
As a trainee and qualified solicitor you should be mindful of the importance of achieving profitability and be as efficient as possible in your working life.
Some tips for firms and fee-earners to maximise profitability are:
- Work productively and efficiently
- Increase fee-earner charge-out rates
- Record billing time accurately [find out more about billable hours]
- Bill quickly and chase for payment promptly if required
- Explore investing in technology to speed up general admin tasks
- Cut unnecessary expenses
- Be mindful of resources and allocate commoditised work to less senior staff, thereby increasing leverage
The current economic growth is very encouraging for those entering the profession. When you begin your legal career keep in mind the importance of financial control and maximising profitability, as you can play an important role in helping to boost your firm’s performance.
Sej Lamba is a trainee at Hanne & Co. Her previous articles on the business of law can be found here.
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