LONDON — Not only does the start of April see the onset of spring (and in my case, the first BBQ of the year), it is also the time when NatWest release its NatWest Legal Benchmark Report 2016. The report is of note because it explores the financial performance and health of small and midsized law firms from an accounting perspective.
This perspective gives the reader a deeper analysis of the drivers behind the financial performance of law firms — much more than the very high-level total revenue, PPEP (profit-per-equity-partner) and other metrics typically provided in some of the legal press.
NatWest’s 2016 survey focused on 390 law firms across England, Scotland and Wales with revenue up to £35 million (US$55 million). And the tagline to the report sums up the findings nicely — “2016 Legal Benchmark Report: Law firms need to avoid complacency”.
Overall, the headline figures are generally quite positive:
- median PPEP is nearly 4% better than last year;
- there has been a 6% increase in fees; and
- median fee-per-fee-earner has risen slightly by 4%.
When you scratch below the surface, however, a more nuanced picture starts to emerge, revealing some very interesting findings which have a direct impact on some of our thinking and the way we look at this market.
Some of the findings of note include:
- The rich are getting richer. Despite the average fee-per-fee-earner rising 4%, this doesn’t represent positive news across the whole segment. The difference between the upper quartile figure of £200,000 (US$288,000) and the lower quartile figure of £113,000 (US$163,000) is 77%. This difference has grown over the past year which indicates real danger for those not focusing on this area. It is essential for law firms to really address the productivity of each fee-earner to support sustainable growth.
- It isn’t just about the amount of growth — how a firm grows is more important. The headline growth in fees of 6% is impressive but what is more important is that this has been supported by an 8% growth in recovered rates. This indicates small and midsized firms are attempting to reduce the amount of time written off and therefore ultimately feeding through to an increase in profit (also up 8%).
- London is unique. As much as the rest of the country doesn’t like this fact, it is true that the London legal market is at a different level in terms of revenue-per-fee-earner, profit margin and other general growth metrics.
- Lawyers love Facebook (or business development). The average level of chargeable time being recorded is 1,000 hours per fee-earner per year. This equates to an average of 4.4 hours per working day. There are clearly tasks that lawyer are performing that they do not believe are chargeable or there is a fear of write-offs. There are tools and solutions that can ensure a reduction in the amount of this “non-chargeable” work — unless it is genuinely time spent on Facebook, in which case lawyers may have to deal with that on their own.
- Forget your bank — go to a law firm. Law firms seem to be in the market of providing short-term finance solutions to their clients. “Lock-up” is the time, in days, it takes for a fee-earner recording work to the firm to when cash is received for that work. On average, law firms are taking 109 days from when they undertake a piece of work to when they receive payment. Throughout this 3.5-month timeframe they are, in effect, funding the work on behalf of their client. This is incredibly dangerous for some firms — it wouldn’t take much for some of them to experience a significant cash flow problem, even if the work is still coming in. By speeding up matters and reducing the time it takes to get work done, firms ensure that they receive the cash sooner, which is essential for funding ongoing operations. This is further amplified by the report which states that based on the median bank balance of a law firm and the median spare overdraft capacity, the median firm would run out of money in about 36 days if they received no further money from clients in that period. This shows how essential it is for firms to emphasize speed in turning around work that ultimately leads to recovery of fees, or to engage in clear matter-planning with agreed-upon partial payment milestones.
Reading the overall report is particularly pleasing from a strategic perspective, and the outlook for coming year is equally interesting:
- 25% of large firms (those with annual fees of more than £5 million [US$7.2 million]) think fee income will increase by more than 10%; and 12% of small and midsized firms believe they also will achieve this level of growth.
- 17% of large firms believe profits will increase by 10%; and 8% of small and midsized firms believe the same outcome will be achieved.
As the report indicates, it would be impossible for firms to be the best at everything, but if a firm focuses on achieving the same performance as those within the top quartile for gearing [a measure of fee-earners to partners], hours billed, recovered rate and margin then a firm currently operating in the lower quartile could increase its overall PPEP figure tenfold.