Increasing profits

Solicitors are selling their skills to an increasingly demanding marketplace. This pressure puts further strain on the equity partners.

Pressure comes from clients, employees, government bodies and technical advancement in service provision. Finance partners in the legal profession need to come to terms with the increasing demands on the working capital and its effect on business cashflow. Working capital is a result of changes in these areas:

• Conversion of charged work into work in progress;
• The invoicing and ultimate collection of debts; and
• Staff utilisation, overhead recovery and direct costs.

All these areas can be successfully managed by a forward-thinking practice, but few practices discuss management of working capital. Practices today require greater financial control through effective management procedures.

Apart from the ability to record transactions accurately using current software, the introduction of the legislation incorporating UITF 40 and the effects of government legislation in other areas, has meant that over the last two years, those practices not managing working capital have seen reduced profits.

Good practice/bad practice

A professional office looking to reduce working capital requirements and increase profitability must apply the following techniques:

• Set standards;
• Monitor workload and staffing levels;
• Provide workable targets to fee earners;
• Review capital requirements and make reasonable comparisons with previous years;
• Improve debt collection procedures;
• Monitor and review direct costs and overheads on a regular basis; and
• Set achievable targets and review regularly.

The following holds professional firms back and reduces profitability:

• Poor training;
• Lack of internal management skills;
• Poor debt collection procedures;
• Lack of work in progress management;
• Inaccurate management information; and
• Autocratic equity partners.

When comparing legal practices across the country, UK200 Legal Group and other bodies are able to actively benchmark their clients with others in the sector and identify wide variances in practice performance across all areas. As accountants to the legal profession, it is important we help and advise clients how to improve performance, even if the practice is already efficient, as there are always improvements to be made.

Example 1: good financial management

An eight-partner practice used good financial management over a period of years. The introduction of UITF 40 compliance helped the practice change its thinking and approach to its cashflow and successfully reserved sufficient working capital to take advantage of the recent change in pension legislation.

The creation of a SIPP in order to purchase office premises proved attractive and because of their attention to these issues, the funding proved seamless with significant pension advantages and continued success. Partner profitability is still improving.

Example 2: injecting 'fresh blood'

Partnerships evolve over many years. Traditionally general practice partnerships relied heavily on partner capital, bank borrowings and haphazard cashflow management. When young equity partners join a traditional practice with older partners there is always a transitional period where the younger partners bring in new management ideas. The older partners need to react favourably to these 'new ideas'.

Practices can significantly improve their cashflow to pay out capital accounts but, more importantly, cater for the requirements of young partners coming in.

Practice development, successful target setting, management techniques and cashflow forecasting, even during the recent difficult times, enabled this practice to pay out older partners earlier than would normally be the case. Investment in IT and communication, will also help recruit higher quality of young professional staff. Similarly, this will expand a firm's client base and help with its image as a progressive firm . The benefits of good management techniques follow through into marketing the firm and if the firm is seen as efficient and well managed, there is little doubt that this automatically attracts a better quality of client.

Example 3: forced merger

Conversely, a struggling three-partner practice '“ with two partners in their late 50s and the more junior partner in his mid-40s '“ was forced to merge with a more successful practice.

The older partners had not invested in partnership development. The cashflow was always slow and their 'ratio' of equity partners to fee earners was very low, leaving little room to improve cashflow and profitability.

The practice struggled to find quality trainees or young solicitors and the older partners could only retire by combining with a larger practice at a reduced rate.

Bad management creates a poor performing practice. Staff and clients recognise this as well as professional contacts and it is a recipe for further problems in future years.

It is important that legal practices have a close relationship with their accountant. This ensures they comply with increasing legislation, will not have problems with the application of SAR compliance and will improve the management of working capital.

This should include forecasting, changing management views and being pro-active and sensible to the needs of the individual firm.