Many firms have seen profits squeezed in the past few years. In some practices, partner profits have declined dramatically since the heady days at the turn of the millennium, when many law firms were experiencing record profits. But as 2003 began, management boards were confronting very different issues

Costs have been shooting up due to smart new properties, record assistant salaries and heavy IT expenditure, not to mention soaring increases in professional indemnity premiums. When income levels were rising from an active and expanding client base, sufficient cash was being generated to settle these costs, but more recently, firms have found that even a small drop in income can lead to a rapid reduction in profitability. For firms where the fall in income has been more dramatic, the impact on the bottom line is frightening.

But there can be winners even in this environment. They are the practices that assess the problems and take appropriate action. The losers are firms that stick their head in the sand and do nothing. So what should a law practice be doing now to enable it to prosper through the year ahead?

First, ensure that you have accurate and up-to-date management information on which to base any decisions. The business then needs to review its cost base in a sensible, pragmatic fashion and ensure it communicates the reasons for this analysis and any resulting decisions effectively with everyone in the firm. Cost-cutting can be a strength, but without proper communication it will seem as if the firm is in trouble.

The key cost to most businesses is payroll. In most cases this expense is fixed in the short to medium term, and to manage this cost base businesses must have the ability to predict “orders in the pipeline”. Staff flexibility can be helpful. Employing people on a temporary or part-time basis, transferring staff or projects between offices and deferring timetables may provide potential solutions.

The instinctive response to a downturn is often to cut costs such as capital expenditure, marketing, training and recruitment expenses. While such cuts can produce an instant upturn in profitability, these functions create foundations for the firm's future, and so can lead to long-term problems. Firms should review the effectiveness of these expenses and consider deferral or reduction where the benefits do not justify expenditure.

Other overheads such as utilities, travel and subsistence costs, IT procurement, maintenance, insurance and professional fees all tend to receive less attention when profitability is rising. A careful review of these areas throughout the business cycle can produce savings in what are often extremely competitive markets for service provision.

Dealing with costs is just one side of the equation. If the business could simply sell more this may raise profitability and solve the problem, but the ability of the firm to influence sales may be limited. Practices must seek to turn these quieter times to their advantage by using the time to review strategies and objectives and improve long-term planning.

The firm must always aim to protect its cash position by invoicing and collecting debts promptly, and where possible, deferring payments.

Firms may potentially consider reducing fee rates to ensure staff are occupied and morale is maintained. But take care not to restrict your ability to raise rates in the future. Concentrate on building relationships with current clients – they are likely to be suffering from an economic downturn as well. When market conditions improve they will want to turn to the advisers who looked after them during these difficult periods.

Crucially, management must communicate with partners and staff to ensure appropriate messages are relayed and misunderstandings avoided. While the businesses that do nothing may lose out, the most painful effects will be felt by those firms that review their position and implement strategies, but fail to communicate these effectively to everyone in the organisation. Not only will these firms suffer from poor profitability, but also from the fallout emanating from the fears and misconceptions that arise from weak management. These fears can be even more divisive and harder to resolve than poor profitability.