Offices of profit

Variations in levels of overheads, capital and debtors revealed by the 2003 Cost of Time Survey, and some exercises to determine fee-earners' profitability

The Journal, April 2004, page 24

Our first article examined the profitability of the firms that took part in the 2003 Survey of Law Firms in Scotland and looked in particular at the importance in the relationship between salaries and fee income. This article considers overheads and moves on to examine the issues of working capital and the amounts partners have tied up in their firms.

On average, non-salary overheads represented around 29% of fee income for the 271 firms that participated.

Chart 1 indicates that in the most profitable firms, overheads were under 25% of fees (30% for 5-9 partner firms); however they were over 35% in the least profitable. This chart analyses overheads as a percentage of total fee income according to whether their profit per profit-sharing partner is:

Below the 25% point; above the 25% point but below the mid-point; above the mid-point but below the 75% point; or above the 75% point.

Cutting overheads has frequently been the first area partners have turned to when there has been a need to improve profits. In practice however there is often limited scope to cut overheads. Many are fixed, at least in the short term – rent, rates, professional indemnity insurance, depreciation – and these may represent a significant proportion of the total. The main overheads that can be cut would include marketing, training, IT, but these are arguably the last that should be cut – they represent investment in the future of the firm.

It is good to review your overheads periodically; however do not expect significant savings. Areas to look at would include stationery, insurance, accountancy, cars, subscriptions.

It is also interesting to calculate the overheads per fee-earner for your firm. This is simply done by taking the total overheads for your firm (excluding salaries) and dividing by the number of fee earners. For example, if your overheads were £300,000 and you had 12 fee-earners, overheads per fee-earner would be £25,000.

Chart 2 illustrates this benchmark for “country” firms (the full report also includes charts for Edinburgh, Glasgow and Aberdeen, Dundee and Perth). A wide range is indicated with some firms achieving a figure of under £20,000, whilst others are over £30,000.

This is an easy, and useful figure to work out. For example, a sole principal recently asked at a seminar whether the x3 rule still held good for working out fee targets? He was working on one third of the fees to cover the fee-earner’s salary, one third to cover overheads and support staff and one third profit. He had three other fee-earners, the most senior earning £25,000, and relatively high overheads. The figures actually worked out (see table 1).  The calculation indicated a x4 salary multiple was actually needed. The partner had thought that fees of £75,000 would have generated a profit of £25,000, whereas actually at that level the fee-earner was not even covering his costs.

In addition to looking at profitability, for the last four years the survey has also considered working capital.

The average capital per partner was £52,000. However, in many smaller firms a far lower amount was required. In a quarter of sole principals, this was under £11,000. In other firms the equivalent figure was over £100,000, and in some firms very much higher, as indicated in chart 3.

Chart 4 indicates the range of outlays in the firms. Similar patterns emerge for debtors per fee-earner. Some care needs to be exercised when considering these benchmarks as they are very much influenced by the type of work undertaken. However it can be interesting to work these out for your firm, and individually for your various fee-earners.

It is especially useful to work them out for different fee-earners doing the same types of work. Are there differences? Does it make sense that one fee-earner’s debtors and outlays are very much higher than someone else doing the same work, or are they poorer at asking for outlays in advance and getting paid?

Billing, time recording and getting paid have always been important. They are likely to take on even greater significance in view of the uncertainty presented by the changes on income recognition (FRS 5: see Journal, March 2004, page 50). Are your fee-earners time recording, are they billing as agreed, and are they billing at the earliest possible stage?

All participating firms receive a free copy of “The 2003 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 purchase a copy of the full report which contains a wide range of useful statistics and performance indicators. Priced at £80, this is available from Lisa Hamilton at the Society on 0131 476 8164.

This month the President will be writing to all firms inviting them to participate in the 2004 survey. Participation is free and carries a two hour CPD credit as well as a copy of the survey report. In recent years there has also been a prize draw. This year the prize of a theatre break in London was won by Alistair MacRae of A & JC Allan. The Society is again grateful to Alex Quinn and Partners for sponsoring the prize in 2003.

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, working initially with Professor John McCutcheon and now with Dr John Pollock. His book, Profitability and Law Firm Management, is published by the Law Society in London.

Dr John Pollock, a consulting actuary, was responsible for the administration and statistical aspects of the Cost of Time survey in 2002 and 2003 having taken the place of Professor John McCutcheon on the Law Society of Scotland Remuneration Committee in 2001. John is well known to personal injury, employment and family law solicitors in Scotland through his expert witness work at Pollock & Galbraith Consulting Actuaries.