This year The Lawyer introduced a new metric to its annual basket of law firm financial health indicators. For many equity partners it is the key one.
Our ’days-to-profit’ number measures the time it takes for firms to clear their costs and start making money. Or, as one top 100 equity partner puts it, “to pay off the tax and start working for myself”.
Costs – and more specifically costs saving – is the key theme of The Lawyer UK 200 Annual Report 2010. As we say in this year’s edition, at most firms costs are “predictable and certain […] harder to fudge than PEP [average profit per equity partner … and] even harder to change”.
The only costs variable that firms can adjust with any degree of rapidity, and one that at most firms accounts for around 60 per cent of total overheads, is headcount. And of course, most firms have been taking full advantage of that fact over the past couple of years.
So, barring any more unexpected layoff programmes, at the start of each year most firms know reasonably accurately how much they are going to be paying out in salaries, rent, insurance and so on. Unlike other businesses, law firms have no need to keep buying in components to generate income, so at some point during the year they are going to crest financially.
The Lawyer’s new days-to-profit metric tells you the number of days it took the top 100 firms to generate enough fees to cover their costs. From that point on in 2009-10 everything was profit.
Naturally, the days-to-profit table mirrors the margin table, as it is effectively another way of expressing how much or little net profit firms generate (using The Lawyer’s methodology net profit is the money available for distribution to full equity partners only). But what is particularly interesting is the extent to which it diverges from the PEP table.
Last year, for example, if you were an equity partner at pensions boutique Sacker & Partmers, the firm’s £64,000-per-day revenue meant profit day was 17 October 2009. Everything after that date was gravy.
Sackers, 88th in the turnover table with £23.2m, was the firm that reached profitability the fastest in the entire top 100. It beat Slaughter and May – a firm where equity partners took home more than twice Sackers’ PEP – by six days, and Optima Legal – the bottom-placed firm discounting the profitless Halliwells – by 188 days, or around six months.
Of the UK big four it was Freshfields Bruckhaus Deringer that hit the black quickest last year, reaching profit on 23 October, or day 177, thanks to the £3.1m per day it generated.
Colin Ives, head of professional services tax at BDO, who says The Lawyer’s metric has echoes of accountants’ ’tax-free’ day, believes it has the capability to trigger a debate.
“Generally most firms should be becoming profitable around the same time,” says Ives. “If it’s later it must be because they’re carrying more overheads. Or if they’re handling lower-margin work it means the cost base in achieving its revenue is higher.”
The chairman of Burness Philip Rodney believes the days-to-profit metric is useful when benchmarking his firm against rivals. In particular, says Rodney, it offers more clarity when comparing firms’ performances than the widely discredited PEP benchmark.
“Our concern regarding PEP is that the figures favour those firms with small equity partner numbers,” explains Rodney.
Certainly, highlighting the time it takes firms to reach profitability also highlights some disparities.
Take Irwin Mitchell. Last year the litigation heavyweight’s PEP stood at £540,000, putting it at number 18 in the table. But it took the firm 300 days to reach profitability, a reflection of its low margin and a result that placed it 78th in the days-to-profit table. Total partners? 115. Total equity partners? 52.
Ditto the firm next to it in this year’s PEP table, Trowers & Hamlins. Its £553,000 PEP places it in 17th place, but the fact that Trowers took 306 days last year to reach profitability put it 82nd in the days-to-profit table. Total partners? 110. Total equity partners? 26.
“The figures underline how tight the equity is at some firms,” comments Rodney, whose firm has 26 equity partners out of a total of 38. “Looking at the PEP doesn’t tell the whole story.”
We took a firm’s turnover and divided it by 365 to get a daily revenue figure. Subtracting net profit from turnover gives you a firm’s total costs, which when divided by the daily revenue total tells you the number of days it took during 2009-10 for firms to become profitable.
Using this approach gives a more accurate figure than dividing a firm’s margin by 365, as several have the same margin. Hence Freshfields Bruckhaus Deringer and Slaughter and May, both of which have a 52 per cent profit margin, have a slightly different number of days to profit (Slaughters is one day quicker at 176 to Freshfields’ 177).
The days-to-profit table in this year’s The Lawyer UK 200 Annual Report is based on the top 50 firms for which The Lawyer has five-year published financial data. This explains why DLA Piper is missing (we ranked the firm in the international table for one of the five years) and why firms with high margins but lower turnovers, such as Sacker & Partners, are absent from the top 50 table published in the UK 200.
To access the UK 200 click here.