Financial health check

Last month’s article discussed the need for firms to have an understanding of their cost base, and the benefits to smaller firms of gradually increasing their size. This month we look at the overall performance of firms in this year’s survey, and look back at trends in recent years.

The chart below illustrates that, after a difficult year for some in 2006, profits generally increased in 2007. The improvement was due to increased profitability amongst the 2-9 partner firms that participated. Profits were static amongst sole principals and fell amongst the larger 10+ partner firms – although the latter is likely to be a function of the small sample involved and changing participants year on year. The 2-9 partner firms are an important group, accounting for over half all firms in Scotland.

The further charts show the trends in profits across the four geographical areas that the survey examines. (We have excluded the larger firms with more than 10 partners from these charts due to the small sample size; also in some cases the variation from year to year in other size groups is due to changing participants and relatively small sample sizes.)

The charts are interesting as they indicate the strong performance of many of the categories of firm. In particular all sizes of “country” firms have shown consistent improvement since 2002. The strengthened performance of Glasgow firms, especially sole principals who have traditionally struggled, is also excellent.

Management points

Financial health is dependent upon many factors, not least the buoyancy of the economy and in particular the property market. Financial management and structure can also be hugely important. Increasingly firms are going to need effective financial management, particularly if the legal services market in Scotland is opened up to external competition and investment.

Some aspects of financial management to consider include:

1. Have an understanding of the firm’s average hourly cost
As discussed last month (Journal, February, 22), it is extremely useful to understand the minimum fees your firm should charge in order to make a profit; to appreciate how your hourly cost compares to other firms; and to understand how it can be made more competitive.

2. Prepare a budget at the start of each year
Set time targets for fee earners, not just in terms of fees but also looking at marketing, training and management. Consider team targets rather than individual targets and avoid over-complex bonus schemes. Few actually motivate fee earners to work better – many merely result in work hogging and undermine any attempt at teamworking.

3. Produce management accounts each month or quarter
These should be as simple as possible and, if the firm is departmentalised, should show departmental or team profitability.

4. Focus on a small number of key performance indicators (KPIs)
There should be a “pyramid” of information within the firm so that everyone is focused on the same indicators. These should start with the firm-wide management accounts, but should flow through team and individual reports.

5. Effective time management
The starting point is that all fee earners should time record, and that they record both their chargeable and non-chargeable time. KPIs that should be monitored at the individual, team and firm levels are:

• the percentage of the day that has been accounted for – the goal should be 100%;
• the percentage of this time which is chargeable – goals will vary according to fee earner;
• the percentage of the chargeable time which is billed to clients and which the client pays for – a target of 90% would not be unreasonable.

6. A focus on cash

Most successful businesses, both in the law and outside, place a high focus on cash management. This means having a sensible level of partner capital and then setting certain KPIs related to cash management. It is highly likely that a focus on the three KPIs above will have the effect of improving fees, debt collection and the bank balance. Two additional ones would be:

• unbilled disbursements per fee earner;
• debtor days.

7. An understanding of the importance of gearing

The key to many firms’ success is their gearing – the relationship of the equity partners to other fee earners. It is the single most important factor in generating strong profits from highly competitive business streams.

8. A willingness to share information

Some of the most successful firms are prepared to share financial information with their fee earners – it can have a tremendous impact on motivation and understanding.

9. Realism in producing the firm’s annual accounts

It is remarkable how much variation there can be in the lives that fixed assets are depreciated over; in the policy regarding bad debts; and in work in progress valuation. The result can be unrealistic balance sheets, a particular problem when firms consider merger.

10. Putting someone in charge of finance

All firms will have a cashroom partner, but make sure someone is also looking at the reports and the KPIs, and is taking action on them – make sure your firm has proactive financial management.

The next year is clearly going to mark the start of a period of change for the profession in Scotland, and effective financial management will be one of the prerequisites to success. Firms will also need clear strategies, and they will need to be alert to the possibilities and opportunities – but first and foremost they need a handle on their finances.

Andrew Otterburn is a management consultant and for many years has run practice management seminars on behalf of the Society. He has helped in the development of the Cost of Time Survey since 1999. The second edition of his book, Profitability and Law Firm Management, is published by the Law Society in London. He is a founder member of the Law Consultancy Network, a network of independent law firm consultants.

Dr John Pollock, a consulting actuary, has been responsible for the administration and statistical aspects of the Cost of Time Survey since 2002. John is well known to personal injury, employment and family law solicitors in Scotland through his expert witness work at Pollock & Galbraith Consulting Actuaries.

[FOR CHARTS AND GRAPHS PLEASE SEE PRINTED MAGAZINE/DOWNLOADABLE PDF]

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TAKING PART: THE BENEFITS

All participating firms receive a free copy of “The 2007 Survey of Law Firms in Scotland”, the detailed report upon which this article is based. They also receive a free confidential individual report. Other firms can obtain a copy of the full report, which contains a wide range of useful statistics and performance indicators, from Libby Boid at the Society on 0131 476 8164 (email: libbyboid@lawscot.org.uk).

    In April the President will be writing to all firms inviting them to participate in the 2008 survey. Participation is free and carries a three-hour CPD credit as well as an individual report on cost rates in the firm and a copy of the survey report. In recent years there has also been a prize draw. Last year the £700 prize was won by Campbell Riddell Breeze Paterson, Glasgow. The Society is again grateful to Alex Quinn and Partners for sponsoring the prize in 2007.