Practice management. Maximising your firm's profitability
18 March 1997
The recent recession has left many firms looking at lower levels of partner profit, despite the fact that partners and fee earners are working harder than ever.
A minority of firms have seen a rapid growth in profits over this period. To understand how different firms achieve a range of profitability levels it is necessary to benchmark the profession.
Firms with proper financial management systems prepare three- to five-year business plans in addition to an annual budget.
If a practice only has an annual budget through to the next year end, typically 30 April, what actions are the partners going to take for the following year and the year after? The current pace of change makes it difficult - but not impossible - to plan too far ahead.
Critical issues in business plans which need to be addressed include profitability, solvency, fee growth, staff development and productivity. The plans for profitability should be more sophisticated than simply proposing to increase profit from £60,000 to £90,000 per partner. How will this be achieved? Through higher gross profits stemming from increased efficiency, or from a reduction in overhead expenditure?
When addressing the issue of solvency, firms need to make sure that there will be no unpleasant cashflow surprises. Planning in this area must include thinking about retaining a proportion of the profits each year to finance expansion and deciding how to finance capital expenditure on premises and computer systems.
Fee growth is perhaps the most important issue. A model which has stood the test of time suggests that good firms should aim to achieve profits of one third of their fee income. League tables of profitability reinforce this model with the most profitable firms being those with high fees per partner.
It is possible to understand why the largest firms with fees of £1.2m per partner can earn £400,000 per partner while an average market town firm with fees of £200,000 per partner can earn profits of only £70,000 per partner.
Increasing a firm's fee income requires regular action from partners, although different strategies are available. "Dross dropping" means deliberately getting rid of the worst clients on whom the firm is probably making a loss. Freeing up some time in this way should allow more to be devoted to the better and more profitable clients or to be allocated to attracting better clients.
Other firms may adopt a policy of targeting larger clients because, on average, larger clients are more profitable and fee portfolios will grow faster.
Staff development is important because it is more difficult to make high levels of profit with a high staff turnover. Firms should improve their staff management procedures so they can attract and retain the best people for longer.
Productivity deals with the way in which firms carry out work for clients. It is important to ensure that the cost of doing work is reduced to the lowest possible level. This can be achieved through increased delegation and training, better use of information technology or by changing the mix of fee earners employed by a firm.
But how can firms increase their profitability in the short term? The clearest and strongest correlation with profitability is seen with recorded chargeable hours.
Some firms reach a level of 1,700 hours per year for assistants, while an average is nearer 1,200 hours. It is interesting to note that the firm doing 1,700 hours is often doing the same work and for the same clients as the practice doing 1,200 hours, and the staff in both firms work the same number of hours.
Firms need to work on the detailed methods used for time recording, because if time is not recorded in the first place then it is highly unlikely that it will ever be billed. It is no use simply telling fee earners to "record chargeable time as such". More detailed advice needs to be given which should cover such items as research, travelling, time spent drinking coffee, lunches with clients and so on.
The other short-term issue which firms should review is their ability to turn recorded time into bills and those bills into cash. Ideally a firm will recover all of its work in progress through bills but invariably some time is written off.
Billing is largely a matter of confidence and it is always a good idea for partners to talk through their bills with colleagues before they are issued. Consultation could lead to perhaps another 3 per cent being put on the bill and this typically increases profits by 12 per cent. An increase of 3 per cent is unlikely to make a client go elsewhere next time if the matter has been handled well, but 12 per cent more profit is a considerable improvement.
The speed with which firms convert time into cash can be measured as a number of days. The period between incurring an hour of time and issuing the bill is called work in progress days and the period between issuing the bill to receiving the cash is called debtor days.
The total time for these two periods ranges from 160 days for the best, through to 540 days for the worst. This time represents free credit for clients and firms should not wish to be financing their clients.
Given that different people are motivated in different ways, and that everyone changes, there are no quick remedies.
Motivating people happens by actions and not by thoughts. Good motivators do something to motivate staff.
The following list provides a few practical suggestions as to what could be tried to motivate fee earners and secretaries and so help in the quest for higher profitability.
Ask them - they might help you!
Recommend to others
Budgets and targets
Teach new skills
Ask them - they might be polite to you!
Keep diaries up to date
Advise of whereabouts
Teach new skills
Introduce to clients
Take to some meetings
Planning meeting at the start of each day
Provide clear instructions
Be available to support
Budgets and targets