Professional practices blog: Controlling expenditure will boost profitability
Karen Hain, partner and head of professional practices at Moore and Smalley Chartered Accountants and Business Advisors, discusses the importance to law firms of keeping a tight rein on expenditure.
Many law firms will have recently completed their financial year-ends, which is a good time to look closely at the relationship between expenditure and fee income.
It is clearly essential for any practice to get this balance right in order to operate profitably, but even more so for traditional firms facing competition from new legal services providers such as the Co-op.
The need for fees to reflect overheads
The ratio of income to overheads is the foundation of any law firm’s financial management because the build- up of profitability and working capital begins with fees billed out.
Where revenue is based on hourly rates or time charged to a matter, it’s important to factor in the full impact of overheads. For example, a department with two or three fee-earners who may have secretaries and researchers will clearly create greater expenditure than a sole practitioner, but this isn’t always reflected in the billing structure.
Departments heads must watch all expenditure
Much financial information comes out of a firm’s accounts office, including fees billed and amounts recovered, but there tends to be relatively little detail on overheads, which are frequently treated as a central expense and not allocated to individual departments.
Financial difficulties can develop when departments bill only for their own time and cost their own work without building in an allocation for overheads. Sometimes it is as if teams are sitting in an office imagining the rent is paid by an entirely different organisation. Our strong advice is that the head of department should keep a close eye on the total operational expenditure of the team and incorporate this into the fee structure.
For instance, if you have £100,000 worth of overheads you must include it in your hourly rate. One way is to establish charge out rates so that when you have a new starter, you work out that their basic salary is X, their benefits package is Y and their proportion of overhead expenditure is Z. You should, of course, add a reasonable profit margin to produce a comprehensive hourly rate.
Tackling the issues of fixed fees
The integration of overheads into fixed fees (such as conveyancing) involves different issues. A straightforward solution is to reflect overhead expenditure when you quote for work, rather than opting for the lowest possible price.
However, legal services provided by bulk operators benefit from economies of scale and this may make it very difficult for traditional practices to compete on fees. Firms should look at their overhead structure and identify where expenditure can be reduced.
Savvy solutions are available
In some cases this might be using supervised junior staff to carry out certain elements of a piece of work. In a way this mirrors the methods used by bulk operator legal service providers, with teams of para-planners supervised by line managers and qualified solicitors.
Another way to improve profitability is to work more efficiently, which may require investment in IT. Of course this involves short term expenditure, but you will see returns as a result of working smarter and quicker, without reducing your fees.