SME firms performing well even though chargeable hours fall

Accounts: Fee income up for 13th year running

Small and mid-sized law firms had a good year financially in 2021/22 but could perform better still if their fee-earners were billing the hours they should, research has found.

The annual financial benchmarking survey from the Law Society’s leadership and management section suggested that home working was one of the causes and, as a result, firms were bringing staff back into the office more.

Accountants Hazlewoods analysed data from 155 principally small and medium-sized firms with sub-£10m turnovers, mostly with March or April 2022 year-ends, meaning that the findings did not fully reflect the current cost-of-living problems.

The survey said law firms were resilient, with 75% of participating law firms reporting year-on-year growth in fee income in 2022 with 46% seeing growth of more than 10%.

Median practice fee income increased by 9.2% – rising for the 13th year running – whilst median fee income per equity partner increased by 5.4% to £939,525.

Residential conveyancing and commercial property were particularly strong; most conveyancing firms have increased their fee rates “several times in the last couple of years, and have not reduced them since”.

Median net profit per equity partner (before deducting notional salaries for partners) firms fell by 1.8% to £199,846. When adjusted to include a notional salary cost for equity partners and notional interest on partner capital, the median ‘super-profit’ for the year was down nearly 10% to £100,926.

The survey said: “As life returned to something approaching normality [post Covid], our experience was that most firms continued to see strong financial performance into 2022, as workflow remained strong in most areas.

“However, firms faced a series of new challenges, most notably increasing pressure to raise staff salaries in order to retain and attract good-quality staff, and many saw large increases in their professional indemnity insurance premiums.

“There are mixed views on the benefits of agile working, but it is clear that in some cases there has been a negative impact on productivity.”

These challenges impacted on net margins and profitability, but that was comparing against last year’s research, which recorded the post-Covid bounce-back. “Therefore, despite the drop in overall performance, the majority of firms that took part in the survey have performed very well once again.”

Median fee income per fee-earner in 2022 was £138,925, up 6.4% on 2021, which equated to £126.30 per hour based on what researchers said was a ‘rule of thumb’ of 1,100 chargeable hours a year.

This meant that just over 88% of fees earned by a fee-earner were used to cover their costs, a figure likely to rise given inflation, salary pressure and energy costs.

Put another way, if a firm had a 31 March year-end, it took until 16 February for the average fee-earner to cover their costs for the year, and for the practice to start earning ‘super-profits’ for the partners.

The figures assumed an average of five chargeable hours per day, but actually it was far lower in many firms, with the median number of annual chargeable hours falling from 863 to 841.

This supported “the growing evidence that working from home is not always as beneficial to the firm as it is to the individual”. As a result, more and more firms were calling their staff back to the office for at least some of the week.

The survey said: “When you consider that a full-time fee-earner working say 35 hours per week has a capacity of 1,600 chargeable hours per year, after allowing for holidays, sickness and training, it is difficult to understand how the actual median can be so low.

“We would expect more senior people with non-fee-earning responsibilities to have reduced productivity, but more junior people with no other responsibilities at all should be looking at upwards of 1,200 or 1,300 hours.”

The survey described these findings as “surprising”, given that many firms complained about recruitment difficulties, “leading to high workloads for existing staff”.

More positively, it recorded that more firms were giving their fee-earners training on issues such as pricing and lock-up management, “and we have seen some very positive results from this, both from an income generation and cash management perspective”.

Other findings included:

  • The median cost of a fee-earner, including fixed-share partners and notional salaries for equity partners, was up 6% to £60,551;
  • The ratio of fee-earners to equity partners increased slightly to 6.25:1;
  • The median spend on support staff was £22,609 per fee-earner, compared to £23,661 in 2021;
  • The median gross margin was 41.1%, down 0.4%, reflecting that fee-earner costs rose by more than fee income; and
  • Total year-end lock-up days (WIP and debtors combined) dropped from 150 days to 140 days.

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