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Finances: big not always better

16 October 17

Bigger law firms are not always the best performing, whether in generating income or in profitability. That is just one of the interesting findings from the Society's new financial benchmarking survey

by Nicola Whiteford

How does your firm compare to others? How much income does your firm generate? How much do you spend on running your business?

These questions were asked of the legal profession in Scotland as part of the Society’s new financial benchmarking survey to review the health of Scotland’s legal sector. The results are available on the Society’s website.

The Financial Benchmarking Report 2017, published in association with Clydesdale Bank, shows an improving picture for smaller law firms. However, the report also highlights some of the pressures felt by firms of five to nine partners.

We worked with leading technology systems and services provider Tribal to redesign and enhance the previous cost of time survey and the reporting on the survey’s findings. Tribal has produced an overall report, which includes charts showing the key findings from the report. Participating firms have access to their own individual, confidential reports, enabling them to compare easily their financial performance against other participants. They also benefit from a dashboard-style suite of key performance indicators, so they can see at a glance how they are doing.

The survey includes new metrics developed to increase the value of the report and to enable participating firms to gain a deeper understanding and analysis of their business and the wider market place; for example, a detailed breakdown of what firms spend their money on, from office premises to staff training, marketing, and IT.

Small is profitable?

The results make encouraging reading for smaller firms. Firms of two to four partners look to be in good financial health. They have experienced an 11% rise in median profits since 2014 to £82,000 per partner, have good bank balances and low debt. Sole practitioners who took part in the survey also saw an increase in profitability, from £41,000 in 2014 to £50,000. 

Firms of five to nine partners may view the results with concern. Median profit per partner was £96,000, a small increase of 4% on 2014’s result. These firms seem to be facing pressures from the higher costs of operating a larger business, without benefiting significantly from economies of scale.

Income is of course a key driver of a firm’s financial health. As expected, Tribal’s analysis of total gross income per partner revealed that, broadly, income per partner increased with firm size. However, median income per partner for five to nine-partner firms did not follow that trend. Interestingly, median income per partner was broadly similar across the regions reviewed by Tribal.

Outgoings and fee recovery

The survey also investigated some of the issues around the accounting practices of firms. The levels of outstanding debt that a firm has can be a concern to all and is worthy of close attention, particularly by firms with more than 10 partners. It is encouraging that the results have shown that high levels of work in progress were recovered when looked at as a percentage of total fee income. The highest levels of write-off were seen in smaller firms, with a median result of 1.2%, but that means that 98.8% of work in progress was recovered. The level may be reflective of the type of clients that smaller firms take on, and a lack of resource to chase debt effectively.

As part of a detailed look at expenditure, firms are able to see how their salary bill compares with others. Expenditure on staff salaries was viewed as a percentage of firms’ total income. The salaries of staff members can be a substantial outlay for any firm. Interestingly, the results show that the median result for firms with 10 or more partners was 43%, which may indicate that some of the larger firms in the survey struggled to achieve the expected size-related benefits that come from being a larger organisation.

Tribal has analysed the results of how much firms spend on client entertaining, client training and business development as a percentage of total expenditure. The results show that as the number of partners in a firm increases, so does their outlay, perhaps indicating, as Tribal suggests, that larger budgets are made available in larger firms, in order to win higher-value contracts.

“Positive indicators”

We were delighted to be working in association with Clydesdale Bank for our redesigned financial benchmarking survey. Commenting on the survey findings, Sue Carter, Clydesdale’s UK head of Professional Services Sector, said the insights gained by the bank’s Professional Services team from the Scottish legal profession were reflected in the Society’s financial benchmarking survey. She said that regulation, client demand, new competition and technology had not only precipitated change, but created an environment for innovation, adding that there were “many positive indicators in the survey”. Carter also pointed out that while continued consolidation was expected, the day-to-day challenges of generating new and profitable fee income, managing working capital and succession planning would remain priorities for firms.

Of course, the survey would not happen without the firms who participated and we thank all those who took part at the pilot stage and in the survey itself. We would encourage more firms to take part in the next survey, to allow for a deeper assessment of Scotland’s legal market and so they can benefit from the individual reports. You can register interest in participating in the next financial benchmarking survey on the Society’s website at the page given above. 

Nicola Whiteford is a solicitor in the Law Society of Scotland’s research team. Read the full article including charts in PDF format here.

 

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