Australian law firms look to increase resilience.

Local law firms have sacrificed growth forecasts to protect partner profitability in response to challenging economic conditions, according to a study of more than 100 law firms by leading national accounting firm, Crowe Horwath, and the Australasian Legal Practice Management Association (ALPMA).

The ALPMA/ Crowe Horwath Financial Performance Benchmarking Study shows that the average profitability of firms has risen slightly to 9.5 per cent (from 9.4 per cent), while growth forecasts have dropped an average of 2 per cent, from an average of 11 per cent last year to 9 per cent this year.

Crowe Horwath Partner – Professional Practice Advisory, Andrew Chen, said across all tiers, economic conditions of the past 12 months have led to a contraction in the size of firms, particularly at a partner level, and growth outlooks for the remainder of 2014 are also being revised.

“Firms have shrunk to fulfil profitability commitments to partners and they’ve had to make some tough decisions accordingly. Paring back growth forecasts is a natural consequence of this,” he said.

Larger firms – those with annual revenue in excess of $20 million – have been slower to reset growth expectations year-on-year, with the business models of smaller firms more conducive to repositioning.

“Smaller firms are more nimble and have therefore adjusted quicker. Also, many of these tend to operate under an incorporated model as opposed to a partnership, so retaining profits is helping with the working capital of those smaller firms.

“Emphasis is being placed on getting more out of less and firms are beginning to see that their efforts are generally paying off,” he said.

According to Mr Chen, firms also needed to critically reassess the financial management and models they operate in. “There has been a lot of change in recent times, so reviewing forecasts in line with the operating model and amending where required will be vital to the sustainability of these firms and the health of the sector more broadly.”

ALPMA President, Tony Bleasdale, said the results showed that firms are effectively managing their cash flow and costs to protect partner profitability in a challenging environment.

“Partner profitability is typically achieved at the expense of revenue growth, and this is not a sustainable approach for firms who want to thrive and prosper in the new legal landscape,” he said.

Mr Bleasdale called on law firms to adjust their focus on strategies that will drive growth.

“Cash is king in this environment, and the study show firms have improved their working capital management which is a good start.”

“Law firm leaders need to continuously challenge the way things are done, to reward innovation and look for new ways to satisfy increasing client demands and strengthen their competitive position”, he said.

Other key findings from the ALPMA/ Crowe Horwath Financial Performance Benchmarking Study include:

• Gross profit margins have declined 2.2 per cent across all firms to an average of 55.3 per cent, representing a 7 per cent decline over four years. Competitive pricing, increasing salary costs and a drop in revenue have contributed to pressure on margins
• Average revenue per partner remained consistent across each tier of firm year-on-year, with the largest recorded change in the $5m – $10m category, where partners generated a revenue increase of $113,000 on the previous year
• Overall, firms have become less financially resilient despite improved working capital management, according to the Crowe Horwath Financial Resilience Index (2.23 this year compared to 3.02 last year). This indicates a reduction in the multiple relating to the revenue generated from available funding resources/ financial investment in firms
• Average lock-up days (the time taken to complete matters, invoice and collect fees from the client) reduced, from 155 days to 147 days in this year’s study. Four years ago, the average was 176 days.

The ALPMA/ Crowe Horwath Financial Performance Benchmarking Study uses Crowe Horwath’s proprietary benchmarking tool, Open Measures, to compare participating Australian law firms. This is the fourth consecutive year the study has been undertaken, with the aim to assess the financial health of legal practices and help firm’s benchmark performance to their peers.

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