Financial stability for law firms: Cashflow, profitability and financial reviews
In the third of a series of articles examining the issue of financial stability for law firms, Karen Hain, head of the professional practices team at Moore and Smalley and MHA, outlines how meticulous examination of financial information can improve profitability.
It has always been essential for any practice to strike a profitable balance between expenditure and fee income.
However, with competition from new legal services providers, it is even more important for traditional firms to deliver financial stability and commercial success.
Overheads must be factored into fees
The basis of any law firm’s financial management is the ratio of income to overheads, because profitability and healthy working capital are built on fees billed out.
A great deal of useful financial information comes out of a firm’s accounts office, including fees billed and amounts recovered, but there tends to be little detail on overheads, which are often treated as a central expense without being allocated to individual departments.
Financial difficulties develop when departments bill only for their own time and cost their own work without taking account of overheads – as if the rent is paid by an entirely different organisation. The head of department should monitor the total operational cost of the team and make this integral to determining the fee structure.
Fixed fee issues and how to avoid them
Different issues are involved in the integration of overheads into fixed fees (for example, conveyancing). A simple solution is to reflect overhead expenditure when you quote for work, rather than opting for the lowest possible price.
The problem here is that legal services provided by bulk operators benefit from economies of scale that may make it difficult for traditional practices to compete on fees. Firms would be well advised to look carefully at their overhead structure to see where costs can be reduced.
Some services can be sold as a ‘loss leader’ if you are confident that you can sell other profitable services to your client, but this has to be monitored extremely closely to ensure there is a strong enough business case for doing so.
How strong risk management translates into commercial success
With traditional law firms facing the challenges of the Legal Services Act under outcomes-focused regulation (OFR) the need for good risk management is greater than ever.
Firms are responsible for meeting requirements set out in the SRA Handbook and operating effective risk management systems. Once again, a great starting point is the Law Society’s Lexcel Practice Management Standard, which provides professionals in law firms with a management framework to drive operational efficiencies, effective risk management, cost reductions, and greater profitability.
If you would like to discuss a legal practice financial management issue, please call Karen Hain on 01772 821021 or e-mail firstname.lastname@example.org