Financial Management. Wake up call to competitive practice

The trend of recent years continues, as more than 70 per cent of firms responding to the fifth The Lawyer/Coopers & Lybrand survey reported increased profits, with strong performers at both ends of the size spectrum. Nearly 90 per cent of the larger firms, those with 30 or more partners, reported increased profits while 94 per cent had improved billings. By comparison, 95 per cent of the smaller firms, those with four partners or less, reported increased billings per partner, although profits were average.

But for 10 per cent of firms, 1996 is a year they would rather forget – their profits dropped by more than 10 per cent.

The survey discovered that the firms which are increasing profits and fees per partner are those which devote more time to marketing. For the first time, the 1996 survey analysed partner time and this revealed a break down of: chargeable time 69 per cent; administration 12 per cent; holiday 9 per cent; marketing 6 per cent; training 3 per cent; sick 1 per cent.

The responses show that firms making big profits do not have higher chargeable percentages. But on average they spend nearly twice as much time on marketing (12 per cent) and less time on administration and on holiday. These high profit firms are also twice as likely to employ a marketing professional.

The merger question

Today's law firm operates in a competitive environment. Yet the survey, of the top 1,000 firms in England and Wales, found nearly a third had no documented business plan or strategy covering the next three to five years. This level has stayed constant for a number of years and the lack of a long-term strategy is worrying in today's business environment.

Nearly 40 per cent of those firms with a business strategy include merger as a probable option. Analysis of the survey results reveals both highly profitable and less profitable firms are equally likely to be considering merger as an option. However, it is firms generating average profits that are thinking about the issue hardest.

The region most likely to experience merger mania is the North West and if the figures for Yorkshire, Humberside and the North East are disaggregated then the North East-based firms are equally likely to be considering merger. The findings confirm the commonly held view that much of the consolidation within the profession in the Midlands, Central London and Yorkshire and Humberside has taken place and that other regions are now moving into this phase.

Using people effectively

Law firms performing well at the profit line have better staff to partner ratios than the norm. Too many firms are still not addressing this issue but it is encouraging to see 36 per cent of firms now operating with a ratio of three staff per partner or more. But there is evidence that firms could do better in this respect, and managing partners would do well to challenge the orthodoxy in their firms about these ratios. The survey also shows that more firms are now employing legal executives.

One area where firms have moved ahead is in the recruitment of full-time professional managers to run finance, marketing and personnel activities. For those firms reporting profits of over 30 per cent of fees delivered, 75 per cent employ full-time finance and personnel professionals and are twice as likely to employ a marketing professional. Those firms making a profit of less than 20 per cent of fees billed compare badly, with only 52 per cent employing finance professionals, 30 per cent personnel professionals and only 16 per cent having marketing support.

People, performance and pay

The 1996 survey sought information from law firms on the salary levels for full-time practice support managers, over one in five of whom earn more than £45,000 per annum. The survey analysis also shows that firms performing well at profit level are those which tend to pay higher salaries to their full-time practice managers.

The 1996 survey looked at human resource processes for the first time. Ninety-eight per cent of firms reported that they organised technical and professional training courses for their staff with 73 per cent organising sales courses and 53 per cent commercial courses. Firms buy in 75 per cent of their training with only 25 per cent being delivered in-house. This lack of marketing support people in firms with a low level of selling skills courses is worrying.

Fifty-three per cent of the largest firms have formal promotion processes, concentrated in the area of promotions between staff and partner level.

Eighty per cent of firms have a formal appraisal system. Most of these apply below partner level but 80 per cent of firms use the system for their salaried partners – the percentage falls off to 63 per cent of equity partners subject to a formal appraisal. With only 27 per cent of firms responding that they had increased their partner numbers it is clear the promotion hurdle is quite high. And with the route to partnership no longer clear, firms need to consider the impact on staff motivation of staying in the same grade for a prolonged period. The survey discovered most firms' career ladder only had three rungs below equity partner level; most accountants have five or more.

Fifty-three per cent of the largest firms intend to seek accreditation under Investors in People and although smaller firms do not have similar plans, they are more likely to apply for ISO 9000/BS 5750 awards.

The survey found there has been a shift towards performance-based remuneration with 22 per cent of firms reporting that they now use the system – only 15 per cent did last year. The largest firms have moved decisively for performance-based systems with 56 per cent opting for this system. Fifty-five per cent of firms said they had reviewed their profit sharing arrangements and 25 per cent said they had changed their basis for sharing profits.

Managing finances

Ninety-five per cent of firms prepare management accounts within two weeks of the month's end with 72 per cent preparing their management accounts within a week. Monthly management accounts rarely include a balance sheet but nearly always include a profit and loss account and an analysis of fees per fee earner. Profits and fees are clearly two of the main performance indicators for firms.

This year's survey looked specifically at partnership financing and found that 60 per cent of funding capital is provided by partners either in fixed capital or current accounts while the office bank account provided 20 per cent of financing and term loans gave a further 15 per cent. The remaining 5 per cent is mainly financed by leasing companies.

One of the key features of partnership funding is whether the partnership owns its property. Seventy per cent of firms rent property, the other 30 per cent are owner-occupiers and 82 per cent of term loans are taken out to finance fixed asset purchases or improvements.

For a number of years the survey has monitored the level of investment in clients as a proportion of fees billed per annum. In 1996 we reduced the cut off point to 100 days and 12 per cent of firms this year say they have less than 100 days investment in clients – a significant achievement. Law firms are also good payers. Only 7 per cent of firms take over 60 days credit from their suppliers and more than 50 per cent of firms settle their suppliers' invoices within 30 days.

Fees billed per partner is a key measure of profitability and while three times more firms billed over £750,000 per partner in 1996, this still only accounts for 6 per cent of firms; 55 per cent billed less than £250,000 per partner.

The Coopers & Lybrand model of good practice has previously indicated that staff costs should be no more than 40 per cent of fees. This category of expense has not been analysed separately before. Information supplied by firms reveals that 49 per cent of staff costs are professional, 32 per cent secretarial and 19 per cent support staff. More profitable firms spend a larger part of their salary bill on professional staff and less on secretaries.

While profits have increased, there are still problems over profits available for partners on fees billed. The number of firms which made over 25 per cent profit per annum dropped by 10 per cent and a disappointing 25 per cent still made less than 20 per cent. Pressure to contain fees and increasing staff costs signal that management must address working practices. To maintain profitability staffing ratios must be addressed.

Fifty-seven per cent of firms do not believe they need to consider limitation of liability – a dangerous 'head in the sand' stance. But one firm in five has formally considered limitation and of those about half have looked at incorporation and conversion to limited liability partnership. However, less than 40 per cent have considered limiting liability by contractual agreement with clients.

A brighter future?

Looking to 1997, firms are again predicting a bright future. 60 per cent are expecting to increase fee earners, with 63 per cent also expecting profits per partner to increase; 57 per cent expect their cash position to improve. Last year 43 per cent of firms expected to increase the number of partners while only 27 per cent of firms did so. This year, 38 per cent say partner numbers will increase. The area with the least attractive prospects for partner candidates is the South West and Wales, where only 13 per cent of firms expect to increase partner numbers. But staff in Central London and the North West have the greatest chance of making it to partner, with 55 per cent of firms expecting to increase their partners in Central London and 50 per cent in the North West.

Over the past five years, firms have tended to be over-optimistic about partnership admission. It will be interesting to see if 1997 lives up to the rosy picture painted.