Foundations of sound finance

The Coopers & Lybrand annual survey into the financial management of law firms for The Lawyer is now in its fifth year. The 1996 survey shows that the profit trend is continuing upwards, with more than 70 per cent of the firms that responded reporting increased profits.

Performances in 1996 were particularly strong at the extremes of the size spectrum: nearly 90 per cent of the largest firms (those with 30 or more partners) reported higher profits, while 94 per cent had improved billings.

Similarly, 95 per cent of small firms (those with four partners or less) reported increased billings per partner, although profits did not show a similar growth.

However, while profits overall have increased, the profits available for distribution to partners as a proportion of fees billed give less cause for optimism. This year 10 per cent fewer firms reported margins over 25 per cent, with a disappointing 25 per cent of firms making less than 20 per cent. However, 22 per cent of firms continue to enjoy margins over 30 per cent of fees billed. By comparison, the first Lawyer survey in 1992 showed approximately 24 per cent of firms enjoying margins greater than 30 per cent of fees billed.

The survey also correlated the responses to identify the key features which distinguish the most profitable firms (that is those firms achieving margins of more than 30 per cent on fees billed) from their less successful competitors.

One of the principal pressures on margins is the movement in staff costs. In 1992, 42 per cent of firms reported staff costs of less than 40 per cent of fees. By 1995, favourable market conditions had resulted in an increase to 53 per cent of firms achieving this benchmark. However, one year on, only 40 per cent of firms enjoyed this level of staff costs.

As you would expect, the profitable firms have their staff costs under control. The 1996 survey results indicate that an annual expenditure of between 41 per cent and 44 per cent of fees billed has become the norm. The analysis shows that 66 per cent of firms making margins of 30 per cent-plus on fees billed spent less than 40 per cent of their fees on staff costs.

It is also apparent that the most profitable firms spend a large proportion of their salary bill on professional staff and less on secretarial support. This correlates with the information which has emerged from each of the earlier surveys regarding the ratio of secretaries to partners and staff. Less profitable firms spend significantly more, proportionately, on secretaries than on professional staff.

In spite of the higher proportion of staff costs invested by the more profitable firms in professional staff, these firms are nevertheless more likely to have recruited support staff specialising in finance, marketing and HR.

In 1996, 75 per cent of firms reporting profits of more than 30 per cent of fees billed employ full-time finance and personnel professionals. These firms are also twice as likely to employ a marketing professional. In comparison, of those firms making a profit of less than 20 per cent of fees billed, 52 per cent employ a finance professional, 16 per cent employ a personnel professional and 19 per cent employ a marketing specialist. It is no surprise that the most profitable firms pay high salaries to their full-time practice managers.

Partners' remuneration continues to be a key issue in law firms. Interestingly, 45 per cent of under-performing firms do not have a formal partner remuneration system, while only 14 per cent of firms generating profits of more than 30 per cent of fees delivered do not have a formal system: in other words, 86 per cent of the most profitable firms have a formal partner remuneration system.

Last year the survey showed that law firms which remunerated their partners by traditional lock-step methods were more profitable than those using performance-based measures. This year, with firms moving increasingly towards performance-based remuneration for partners, the position has reversed. In 1996, those firms generating profits in excess of 30 per cent of fees billed were twice as likely to have a performance-based system as the less profitable firms.

This year we asked firms for the first time how their partners spent their working hours. Across the board, partners spend about 69 per cent of their time on chargeable client work. However, partners in the most profitable firms spend double the average amount of time on marketing. Given that we have seen that profitable firms are also twice as likely to employ a marketing professional, it is probable that effective marketing activities will generally lead to improved profitability.

While there is no guaranteed recipe for financial success, the annual surveys provide information on a number of features that distinguish profitable law firms from their less successful competitors. It may be worthwhile checking whether your firm has the right ingredients.

Denise Catterall is a partner at Coopers & Lybrand and is head of its London Partnership Group. For further information contact her on 0171 213 8780.