Know your books

It will come as no surprise that profits fell substantially in the 2009 Cost of Time Survey. Median profit per equity partner fell by 31% from £104,000 the previous year to just £72,000. Sole principals and the larger 10+ partner firms suffered most, with falls in median profit per partner of 45% and nearly 40% respectively, as illustrated in the chart below.

The survey was based on a good response with 233 participants, representing 19% of all firms in Scotland.

The figures are in line with the results of a survey of firms in England & Wales published by the Law Management Section (LMS), part of the Law Society of England & Wales. (LMS member firms tend to be more profitable than the profession generally in England & Wales and the figures are not representative of the profession. Very few sole principals took part in the LMS survey.) Based on a sample of 180 firms, median profit per equity partner fell by 26%, with the greatest reduction, amongst 2-4 partner firms, of 45%.

Still a challenge

Because the “average” year-end of the participants in the Cost of Time Survey was December 2008 it is quite possible that profits will fall again when this year’s results are published. In particular, during 2008 firms were still earning reasonable amounts of interest; however rates have been very much lower during 2009, and for most firms any interest earned on client account has virtually disappeared.

2010 is likely to be equally challenging and it is important that partners maintain and if possible strengthen financial management within their firms. In particular they should:

• 1. prepare a budget at the start of each year;
• 2. produce simple management accounts at least each quarter so you know how you are doing against the budget;
• 3. identify and monitor a small number of KPIs (key performance indicators);
• 4. maintain a three or four month cash forecast.

Guidance on these areas and others is provided in a new guide produced by the Law Society of Scotland,

From Recession to Upturn – Financial management and strategy for law firms. Copies can be downloaded from the Society’s website.

Budgets

Many smaller firms do not prepare a budget, yet they are easy to do and help to provide a financial plan for the year ahead. They are also very useful when talking to your bank; indeed the absence of a budget may be interpreted as a warning sign by banks of probable poor financial management. There may be uncertainty regarding fees, but that is not a good reason not to prepare one. You are likely to be able to make a reasonable forecast now that the economy appears to be stabilising.

The starting point for a budget is a projection of the firm’s salaries and overheads for the coming year. You then need to take a view on likely fees, and finally what drawings the partners can take. In the current climate that is likely to be at a lower level than previous years, and preparing the budget will help determine what the level should be.

It can often be very useful to share parts of the budget with other fee earners. A degree of openness can sometimes be very helpful in enabling everyone to understand the financial realities of life and why levels of fees, which to some may sound high, are required.

Management accounts

Many firms do not produce regular management accounts, something that once again could be viewed by a bank as a potential warning sign of problems. It can be very useful to:

• aim to close each month’s accounts as soon as possible after the month end, when all the bills have been posted;
• produce management accounts at least each quarter – monthly if you prefer;
• extract some of the key figures into a simple one or two page report – perhaps produced using Excel;
• circulate these not just to the partners but to fee earners as well so that everyone knows how the firm is doing. Motivation is a huge issue amongst many firms, and improved and more open communications can be an easy and inexpensive way of motivating people. A lack of information is often part of the cause of low motivation within firms and it is sometimes remarkable how, even if the information is not necessarily good, people feel better and more positive. They are not being kept as much in the dark.

Monthly reports might include:

• fees billed – by team/work type or individual;
• chargeable hours achieved;
• cash received;
• new matters.

Key performance indicators

KPIs should be highlighted in the regular reports and could be figures such as:

• chargeable hours for month as a % of target;
• actual fees billed for month as a % of budget;
• debtors and outlays per fee earner in each department;
• average fee billed by work type.

Cash flow forecast

A simple cash flow is once again easy to do. The table above illustrates a simple projection for the bank balance at the end of each month and is once again very useful when talking to the bank. This might be something you would expect your cashroom manager to produce, and it may even be useful to prepare something similar on a weekly basis.

So, the basic message coming from the survey is that firms experienced a fall in profits in 2008-09 and a further reduction may well occur in 2009-10. Faced with this, firms need to continue to focus on financial management over the coming months.

Andrew Otterburn is a management consultant and has advised around 250 firms on their management and profitability. He has helped in the development of the Cost of Time Survey since 1999. Author of Profitability & Law Firm Management (Law Society 2007), his new book, From Recession to Upturn – financial management and strategy for law firms, has just been published by the Law Society of Scotland. Together with Fiona Westwood, 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.

Taking part: the benefits

All participating firms receive a free copy of “The 2009 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 the Professional Practice Department at the Society on 0131 476 8164 (mail to: profprac@lawscot.org.uk).

In April the President will be writing to all firms inviting them to participate in the 2010 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 Claphams in Glasgow. The Society is again grateful to Alex Quinn and Partners for sponsoring the prize in 2009.

For charts and diagrams please refer to magazine or download the PDF.