Every year, when we put together The Lawyer UK 100 Annual Report, we get the same refrain: how can you compare firms that have completely different equity structures? Partners from firms with all, or mostly all, equity partners complain that they are not being judged fairly. These firms are constantly frustrated at what they see as manipulation of the figures. Partly, this is based on a philosophical objection. If non-equity partners have `partner' on their business cards, then why judge a firm's success on the earnings of only a small segment of them?

Within a City culture of league tables, there is, to be sure, a temptation for some firms to manage their businesses purely in order to produce headline profit per equity partner (PEP) numbers. Look at the number of de-equitisation programmes firms have been carrying out. In most cases this means turfing out unproductive partners entirely, but it is fuelled by hiking a firm's average PEP to competitive levels.

PEP figures have come to dominate the way in which law firms are analysed, but there are serious flaws in taking such a simplistic approach. But how do you solve it? Hence The Lawyer's grounbreaking research into average earnings per partner (EPP), which will overturn many long-held assumptions about law firm financial management.

With non-equity partners (NEPs) becoming an increasingly vocal constituency, and in many cases making up the majority of partnerships, it is time to include their compensation within the overall calculations of how well a firm is doing. We took 30 of the UK's biggest firms to illustrate this.

But a warning: the all-partner earnings figure should not be seen as a substitute for PEP. In our view, PEP remains a key indicator. Equity partners own the business and put in the capital to fund it. They are the ones taking the risk, so PEP is still a vital measurement. And we take no value judgements about two-tier partnerships. A centralised management culture such as that within DLA Piper Rudnick Gray Cary simply does not suit a sprawling, all-equity partnership model, for example.

However, the EPP figure will, we think, become another key indicator and should be read in conjunction with any discussion of profitability.

The NEPs (whether you call them fixed-share, local, national, mezzanine or junior equity) are regarded by different firms in different ways. Most firms will say that any partner made up to this level is expected to progress to full equity. In the vast majority of cases it will be three years, but the requirements for full equity are much more stringent as firms have started to introduce more rigour into their promotions.

The limited-liability partnership (LLP) model will mean that law firms will have to be more transparent about their remuneration levels. When you look at Allen & Overy's (A&O) accounts - revealed in The Lawyer in July 2005 - the amount of money allocated for NEPs is clear to see.

NEP remuneration is notoriously difficult to calculate. Our research found that NEPs are usually paid a salary plus a small share of the profits, and in many cases an extra bonus on top of that. Earnings can vary within each firm (NEPs based in the regions at DLA Piper, for example, will be paid less than those in London).

However, in virtually all cases, the firms surveyed here were happy to give us a working figure representing average compensation per NEP. Multiply that by the number of NEPs and add that figure to the firm's net distributable profit for equity partners. That total figure is then divided by the global number of partners to give the EPP.

The magic circle
Freshfields Bruckhaus Deringer partners should take heart. It was bested by Linklaters in the average PEP stakes by £145,000 - something that caused much gnashing of teeth at the Fleet Street firm. However, our table shows that, when taking all partner compensation into account, Freshfields not only outguns Linklaters but its profit margin of 45 per cent even beats Slaughter and May - a magnificent achievement.

However, Freshfields partners should not be too complacent. The fact that turnover barely grew to £780m, while Linklaters' gross fees shot up to £805m, should be a cause for concern.

Clifford Chance partners should be watching these figures closely - and should be getting used to disappointment. If the firm does decide to vote for an all-equity partnership, then it will have to steel itself for an average PEP of around £534,000 - our calculation of its EPP. That is nearly £100,000 behind A&O's. Compare that with Clifford Chance's current PEP of £644,000, which is only £5,000 behind A&O's.

What should concern Clifford Chance even more is that its already weak margin of 26.7 per cent only rises to 33.5 per cent - way behind those of its magic circle competitors. Even Lovells outguns it on margin by this reckoning. You can deduce from this that the US is a horrible drain on the global practice; no other magic circle firm has that amount of cost.

The EPP figure even slightly downgrades The Lawyer's Law Firm of the Year, Slaughter and May. In many ways, everyone's favourite elite firm follows the simplest of models. Many people would be surprised to see it having NEPs - in fact, they are located mostly in Slaughters' few foreign offices. But Slaughters has such a simple, pure model that even using The Lawyer's new calculations its partners are scraping by on an average of £998,000, which is £298,000 more than its nearest rival Freshfields.

The chasing pack
Ashurst, Herbert Smith and Lovells have all seen drops. Herbert Smith has 57 per cent of its partners enjoying full equity. Its PEP figure of £809,000 plummets 33 per cent to £538,000. But the firm still comes in above Clifford Chance and just pips that pocket dynamo of a firm Travers Smith, with £529,000. Herbert Smith's margin, on the new figure, rises from 35 per cent to a very strong 41.2 per cent - better than A&O. Its top 10 rivals will be delighted to see its EPP dive, but that profit margin still displays a well-run business.

At £411,000, Lovells has some work to do on EPP. However, its relative position on this calculation looks slightly healthier than its detractors might imagine.

The £300,000 league
The Lawyer has argued that the £400,000-plus barrier has become the benchmark of success in PEP. But when you look at the EPP figure, there is a striking number of firms congregating around the £300,000-plus mark: Addleshaw Goddard, Barlow Lyde & Gilbert, Berwin Leighton Paisner (BLP), Clyde & Co, CMS Cameron McKenna, DLA Piper, Lawrence Graham, Nabarro Nathanson, Norton Rose, Olswang, Taylor Wessing and Wragge & Co. Many of these firms had been in the £400,000-plus, or even the £500,000-plus, range before EPP had been taken into account.

On this basis, we can see how well SJ Berwin does. There are only two firms that remain in the £400,000-plus bracket on adjusted EPP: Lovells and SJ Berwin. Even more creditably, SJ Berwin's profit margin rises to the highest in the land at 46.7 per cent, up from 37.7 per cent.

This dramatic rise in the margin is mirrored by DLA. Its earnings figure for all partners drops 44 per cent, from £535,000 to £300,000 - something jealous rivals will no doubt leap upon. Yet once the NEP pay is taken out from the cost side, the profit margin leaps from 20.9 per cent to 40 per cent - the same as A&O's. That is still good going by any standard. Having said that, the NEPs' average earnings figure of £210,000 is on the generous side, which will have aided DLA Piper's performance in these tables.

And here comes the almost inevitable: Macfarlanes and Travers Smith still enjoy splendid figures, even after adjustment. Macfarlanes' PEP stands at £810,000, while EPP stands at £660,000 - the highest of the £400,000-plus firms. Travers Smith, with only seven non-equity partners, dips slightly from £575,000 to £529,000.

Indeed, it is notable that the top 10 most profitable firms in both tables remain largely the same - it is just the order that changes.

National firms
National firms are under considerably more pressure than others. Costs of multi-site operations are inevitably higher, while differential pay (lower in most regions outside London) will depress EPP. Addleshaws (with an EPP of £322,000), DLA Piper (£300,000) and Wragges (£307,000) are entirely comparable.

While the above trio post strong performances, the clutch of national firms in these tables include four much weaker players: Eversheds, Halliwells, Hammonds and Pinsents. Halliwells at least has momentum on its side, and its EPP of £217,000 is decent enough for a firm whose business is still mostly based outside London.

Pinsent Masons is not really shaping up at all well. Its average PEP was disappointing enough at £234,000, but when all partner earnings are taken into account, it slides to an embarrassing £171,000. Even when the costs of its 126 non-equity partners are taken out of the calculation, it can only manage a profit margin of 28 per cent. That said, Eversheds will be disappointed with its APP of £234,000 (down from £350,000) and adjusted profit margin of 26 per cent. Hammonds' awful story has been widely covered in the pages of The Lawyer throughout 2005.

The Lawyer's EPP calculations give a more rounded picture of a law firm's performance. But one thing is indisputable: however tight you hold the equity, the bottom line remains running the business efficiently.

• A selection of firms and their EPPs
• The Top 10 firms for equity
• Average earnings PP
• Reported PEP
• Equity spreads from top to bottom