Robert Martin analyses The Lawyer/Coopers & Lybrand 1995 survey of firms' financial management and finds good news
It was another good year for the profession, according to the fourth annual The Lawyer/Coopers & Lybrand survey. It was also a year of contrasts. Profits were up, with more firms taking on professional staff, but climbing the ladder to partnership is set to become more difficult with only one in three firms likely to increase partner numbers.
The gap between best and worst is widening: the top performers have strategies, defined markets and quality staff and support systems; the laggards have no plan and inadequate support systems. Some have needed the help of insolvency practitioners.
The Lawyer/Coopers & Lybrand survey has become established as the most authoritative source for firms to benchmark their financial performance. Firms should compare themselves with the profession's leaders and consider what actions they should take to improve their own performance. Unless they do so, the market will 'find them out'. Make no mistake, this is already happening; a number of firms over the last year have entered into voluntary arrangements to protect their partners' livelihoods.
The survey report, which gives comparative details by region and size of firms, has this year also addressed the question of partner remuneration. As law firms become more commercial, it is crucial that they plan their futures.
The survey notes that there are still far too many which do not have a business plan or strategic document covering the next three to five years. One third of all firms surveyed still have no such document.
More worrying is that almost two thirds of firms with four or less partners (which are probably those most at risk) do not have a written business plan or strategy. The problem is a national one, with no regional variation. Against the backdrop of 'trouble in store' for the unprepared, 1994/95 was a good year for most in the profession.
The key trends are: three quarters of firms experienced an improvement in both overall fee levels and in profits available to partners with almost half the firms reporting an increase in partnership profits of over 10 per cent, 60 per cent of firms increased chargeable hours. And 56 per cent of firms reported an increase in the number of fee earners in the year. Only 19 per cent of firms called on their partners for additional fixed capital.
So, on the face of it, 1994/5 has been a healthy one for most firms. Indeed those reporting profits reduced by more than 10 per cent halved to only seven per cent of firms.
However, for a number of years Coopers & Lybrand has argued that the gap between the successful and unsuccessful would continue to widen.
This trend has continued in 1994/5 and we see no reason to change our view. We have commented in the past on the low levels of partner to staff ratios operated by a large number of firms. This is still evident from the 1995 survey. Four years ago when the survey started, half of all firms reported one qualified solicitor for each partner. There has been little progress and similar ratios still exist. It is, however, increasingly clear that it is possible for firms to operate with better staff ratios.
In 1993, 27 per cent of firms reported that they operated with staff ratios of one to three. This has increased to 34 per cent of firms in 1995. Indeed seven per cent of firms reported a partner to qualified staff ratio of better than one to five.
Our findings indicate that generally firms reporting better levels of profit – profit levels of 30 percent or more of fees billed – have above average staff ratios.
This pattern continues when you look at support staff ratios. Sixty five per cent of firms continue to operate a ratio of one secretary per legal professional. Coopers & Lybrand is pleased to see this had reduced from the 76 per cent which reported a one to one ratio when the survey started four years ago but there is room for improvement in this area. Again, firms with better support staff to legal staff ratios deliver above average levels of profitability. For the first time the survey sought to identify the number of firms which employ full-time professional support staff in finance, marketing and personnel.
Overall 59 per cent of firms reported that they employed a professional finance manager. This percentage rose to 86 per cent for larger firms. Twenty five per cent of firms employ marketing specialists but this increases to 60 per cent for the largest firms. We wonder whether or not the fact that larger firms have marketing professionals is one of the reasons for the firms' size. Sixty six per cent of larger firms employ personnel professionals.
For the first time the survey addressed the question of partner remuneration. The key findings are: equity partnership is not normally achieved before the age of 30 with smaller firms tending to admit partners later than larger ones; it is still rare for firms to request new partners to pay for goodwill; 41 per cent of firms do not have salaried partners.
More of the larger firms have salaried partners with three out of four firms with over 30 equity partners having salaried partners. One half of firms operate a lock step remuneration system, with partners reaching parity in profit share over a predetermined number of years. Parity is reached in 50 per cent of partnerships over an average period of up to five years. In the larger firms the period taken to reach parity tends to be longer, seven years being the average.
Fifteen per cent of firms determine partner profit share by assessing individual partner performance through a form of partner appraisal process. This becomes more common within larger partnerships. Thirty five per cent of firms have no formal policy on changing partner profit shares. There is a wide range in the ratio of profit shares between the highest and lowest remunerated partners reported by firms.
However, most firms operate with a ratio of between equality and one to two. We were pleased to note that 77 per cent of firms produced their management accounts within one week of the month end. This conforms with commercial best practice. However, we despair of the 10 per cent of small firms which still do not produce any management accounts at all.
There has been a marked improvement in the investment in working capital in most firms. Thirty per cent of firms reported that their investment was less than 150 days fees. However, 21 per cent still have an investment of more than 236 days' fees. The cost of this will become an unacceptable burden on partnership profits should interest rates rise again. Eighty per cent of firms use unpaid partner tax as part of their working capital. Sixty two per cent of firms stated they will continue to provide for this unpaid tax in their accounts under the new self assessment regime to be introduced in 1996/97.
Thirty four per cent of firms are still undecided on this matter. This is a critical issue facing most firms. The new tax regime will not only reduce the average amount of tax held within the partnership for this purpose, thus reducing working capital, but tax liabilities will also become the personal liabilities of each partner rather than the partnership.
We question whether it is still appropriate to use such balances as working capital for the partnership.
Returning to strategy, the trend of the growing number of niche firms reported last year continues.
These smaller firms tend to concentrate on more profitable areas leaving the multi-service firms to carry out the least profitable work. Despite the changing demands of the marketplace, most firms view the future as rosy, with the majority predicting continued improvements in performance. Ninety per cent do not expect their performance to deteriorate, and 60 per cent expect to increase profit levels. They also expect to increase the number of fee earners and total chargeable hours. However, there is a potential dark cloud on the horizon with the news that only one in three firms expects to increase partner numbers. This will come as a disappointment to the many who have partner aspirations and abilities. Perhaps the rosy future belongs to those firms which not only know and understand their markets, and have systems in place to capitalise on them, but also have the skills to effectively manage the career expectations of their staff.
In our view this is a tightrope which can only be walked successfully by firms experiencing significant profit improvement.
Robert Martin is a senior partner in Coopers & Lybrand.