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North West law firms “must improve financial management” to keep growing, urges report

Karen Hain

Law firms in the North West saw their first overall fall in income and profitability for three years in 2017, according to an influential report on the UK legal sector.

The annual Legal Benchmarking Report from MHA, the UK-wide group of accountancy and business advisory firms, has also revealed a widening profitability gap between the smallest and largest practices.

The research is supported by Lancashire-based chartered accountants and business advisers MHA Moore and Smalley, one of nine MHA member firms.

The changing trends in income and profitability, together with changes in ownership and staffing, point to the emergence of a ‘new normal’ for the UK legal sector, where improved financial management is vital.

Among the issues firms need to tackle are a continuing increase in so-called ‘lock-up days’, which is the sum of a law firm’s unbilled work in progress and debtors. Increased efficiency in billing processes are needed to ensure future financial stability and profits, says the report.

Karen Hain, head of the Professional Practices sector at MHA and a partner at MHA Moore and Smalley, said: “A combination of factors, including fewer mergers and acquisitions, the impact of the fixed-fee regime, and increased competition, have created a shift in the operating environment for firms of all sizes.

“The sector needs to adapt to a ‘new normal’, putting a direct emphasis on having a better understanding of profitability and margins on work undertaken and improved financial controls. Efficiency needs to be a key theme for 2018 and beyond.

“Firms that focus on ensuring the right level of work is carried out by appropriately experienced and costed staff will see improved profitable performance. In addition, firms need to ensure they have a full understanding of the value of their services and are accurately pricing work with appropriate levels of profit built in.”

In 2017, law firms of all sizes from sole trader practices to firms with over 25 partners saw their income fall. Mid-tier firms, those with 11 to 25 partners, saw the largest reduction, with a drop of 11% from 2016. Sole trader practices saw the smallest fall of 1% and the other sized firms saw income reduce by 5% in 2017.

Most firms in the survey also saw a reduction in income per fee earner, with only those with 5 to 10 partners experiencing a small increase of 2.4%.

The profitability gap between the smallest and largest firms continues to grow. For sole practitioners, profits have fallen by 40% to an average of £41,000 in 2017 and nearly 60% lower compared to the levels of profit achieved in 2015. This downward trend is further evidence on the struggle smaller firms face in a marketplace dominated by larger firms.

Level of profit per equity partner have also seen falls, with firms of 11 to 25 partners dropping 13% and the largest firms falling by 8%.

The research revealed a marked change in the staffing structures of legal practices. There are fewer senior fee earners and increases in paralegal and support staff.

Equity partner numbers have seen a drop and this trend is expected to continue, with fewer high paid fee earners wanting to sacrifice employment security for exposure to the risks of equity. This means those that are already equity partners are able to access a greater share of the better returns.

In the latest survey, the level of lock up is showing a worrying continuation of an upward trend first identified last year. For most firms, average lock up jumped in 2017 by between 3 days to 17 days. The rise in lock up days emphasises the pressure on firms having to fund staff costs and practice overheads against a backdrop of falling income and profitability.