What Drives Profitability for Legal Practices
Understanding the change in profit share from one year to another is a key measure looked at by Equity Partners (EP’s) to determine whether the year has been a successful one.
Improvement on the previous year but is it good enough?
The EP’s in the 2-4 partner firms will be happy to see a 17.5% increase in average profit share. However, their profit share of £94,000 is still £1,000 less than that achieved in 2016, and £11,000 less than in 2015. 2-4 partner firms have found the last few years very difficult. These firms appear to have tried a new tactic of reducing fee earner numbers. The removal of some high earning employees has reduced turnover but has had a positive impact on equity partner profit.
The profit divide
There is a real divide between the size of practice and the Profit per Equity Partner (PEP) that are achieved. Bigger seems to certainly be better with regards to profitability.
Where a practice has 1 to 4 EP’s, its Average Annual Profit (AAP) for the last two years is £86,000. Where the practice has 5 to 25 EP’s the AAP for the last two years is £147,000, but for the practices with greater than 25 EP’s the A AP for the last two years is £244,000.
This profit divide seems to fuel the regular discussion in the market regarding the continued consolidation of smaller firms into larger firms.
Are you valuing your work properly?
The net profit as a percentage of turnover statistic is incredibly important for legal firms, showing whether the work that is being carried out is actually profitable. The standard net profit benchmark to aim at is 25% or more. Only the firms with 11 or more partners seem to be achieving this target.
In the market place there seems to be a constant challenge where partners are battling to agree fees with clients. It is easy to increase fees by selling your services at a low fee level, but you will not make any profit by doing so and it appears that the smaller firms are finding it harder to charge fee levels that counter their increasing costs.
Old time is less profitable
Old work in progress is hard to bill. The perception of value from the client is at its highest on the production of the work, so firms should ensure all fee notes are produced and issued when the job completes. Smaller firms, especially, need to make sure invoices are raised on a timely basis to get maximum costs charged. This will help to push up net profit percentages.
What work is profitable?
Firms’ accounting records are all now electronic and as a result, there is a significant amount of data available to analyse. A review should be completed to understand which are the profitable matters. Are they all the same type of matter? If so, maybe the marketing of the firm should concentrate on this type of work. Is it the same fee earners? If so, what do those fee earners do differently and how can other fee earners learn from them? Concentrating on profitable work will push up the net profit margin and in turn the profit to share between equity partners
Call to action
- Review bill recovery rates to see which matter types are earning profits.
- Consider how this profit review impacts on marketing plans.
- Check billing procedures to ensure there is a prompt to prepare the bill on completion of the matter.
- Consider if consolidating into a larger firm to share overheads would grow profits at a faster rate?
Find out more
This article comes from our latest Legal Benchmarking Report. This annual report draws insight from legal practices across the UK and focuses on some of the pertinent issues and trends in income, profitability, employment costs and lock up
Click here to read a copy of the full report.