A message to all small law firms – as principals, you need to make a profit

[Australasian Law Management Journal,Finance & Accounting,General Management,Strategy & Leadership] March 25, 2019

A failure to properly address profitability and pricing confidence has left the principals of many smaller law firms, in particular, to a life of opening their doors without the prospect of an appropriate livelihood, writes Rob Knowsley.

In previous articles in this series, I have dealt with the imperative of clearly understanding the level of work that is needed within a law firm to align with the firm’s productive resources – and ensuring that this alignment is obtained.

Excellent quality of work with good pricing and profitability, on too few matters, will almost certainly ensure that there is no genuine profit at all after taking into account proper remuneration packages for principals. Obviously, the position will only be worse if pricing confidence is lacking. So, the message is that proper profits are essential for the strong financial health of a firm.

Too many lawyers are too quick to downgrade the importance of profit in a legal practice. However, to set the scene for what follows, let us have a quick look at some reasons as to why it is so crucial.

Profit provides principals with a return on their investment in the business; it is, in essence, a reward for risks taken. Remember, though, that it must be viewed separately from a salary for working in the practice.

Profits created have many potential uses. For example:

  • reducing borrowings (whether simply by lowering the level of use of overdraft facilities, or by reductions of the principal of loans), cutting interest expense, limiting anxieties over cash-flow, and minimising exposure to lender demands
  • re-investing into capital purchases not acquired under finance leases
  • re-investing into practice expansion
  • enabling regular and/or ad hoc drawings over and above principals’ salaries
  • allowing an investment of more time in suitable pro bono work, or appropriate reduced-fee work
  • giving more to charity, or investing more time in charitable work
  • making a greater investment in future stability and growth (perhaps via improved or additional marketing, innovation, or IT, or all three)
  • creating or bulking up a sinking fund for future taxation obligations
  • creating a sinking fund purely to be well-armed for unexpected opportunities around the corner
  • lifting, if appropriate, principals’ salaries and associated benefits to proper commercial levels for future periods (strong enough profits will allow these expenses to be properly recognised and increased)
  • investing in improvement of the physical surroundings for the people in the practice and those who visit.

Doing it tough financially

The unfortunate reality is that for a very long period of time most small legal practices have not made real profits when you factor in proper remuneration for each principal working in the practice. In most practices, principals earn less than what they could earn through a complete remuneration package as an employee elsewhere.

The truth is that many principals do not take into account the need to set goals for their own benefits before profit, or the various benefits for employees, including superannuation, annual leave and other types of leave such as long service. Most of those firms that do make real profits have margins in the range of 1 per cent to 15 per cent of revenues. With low profit margins, even quite small increases in revenues can generate increases in profit well over 100 per cent.

Being busy not enough

Most of what is done in small practices each day is just about keeping the doors open.

Law firm managers need to fully understand that being gainfully busy generating revenue for a significant period of each day, week or year is not what creates profits. What creates profits is being gainfully busy generating revenue after break-even, and that point is only reached late in each day, week or year.

To be gainfully busy in the zone that matters as far as profits are concerned, team members need to have enough client file work to do, at proper fees. Quite apart from pricing techniques, pricing well requires a good dose of confidence. It is easier to be confident if there are enough enquiries, so that inappropriate fee work can be ‘politely declined’.

Getting more of the right types of work at improved fees will also assist the firm to reach its unique break-even point more quickly, with fewer matters.

Cover your costs

To re-cap, marketing should be designed to ensure there is properly billable work, with the focus being to reach break-even point to cover expenses.

Almost all revenue generated thereafter is profit, so it follows that, in terms of strongly improving profit, it is vital that there is enough work of the right type, and that it is priced confidently.

With many small-firm lawyers voicing concerns about perceived downward pressure on fees, they need to respond through a combination of better marketing and more confident and skilled pricing, otherwise they will struggle to generate vital profits at levels that will underpin the future financial health of their practices.

Being busy with work that produces relatively poor fees absorbs time that produces little or no profit, and at the same time it reduces the ability to invest time in marketing for the right types of work in the right volumes, at the right fees.

Rob Knowsley is the principal of Knowsley Management Services. He is a high-performance coach and facilitator with four decades of experience that has been dedicated to assisting law firms and their individual lawyers and managers as they seek to maximise their return on investment from reasonable inputs of time, money and other resources.