We all know how the firm as a whole is doing. Annnual accounts and the bank balance give us a rough idea and we also look at FE bills delivered figures at the month end. But do we really KNOW how each area of our activity is performing? Do we know whether it is still worthwhile to be doing crime work, for example? Do we know which areas of our businesses are really contributing to profit and which are holding us back, where our efforts need to be applied and where we can relax?

The bills delivered figures alone are simply not enough to get a true picture of the real profit being generated. And it isn't at all complicated. Try this:

You will need just your last annual accounts and a current salary schedule.

1) Start with the salary schedule and work out for each of your FEs and the staff that support them directly - usually just their secretaries - their true total cost to the firm, taking their gross pay and then adding employer's NI and any other costs such as bonuses, employer's pension contributions, car parking paid specifically for that person, and so on.
You might have something like this:
FE: Fred Conveyancer - £35,000 salary plus employer's NI and pension contributions, total cost to firm £42,500
FE: Susan Family - £38,000 plus same, total cost £ 46,000
Secretary: Jill Speedy - £16,000 salary plus same, total cost £ £19,000.
Jill takes care of 2 FEs - Fred and Susan so add 50% of her £19,000 to each.
We can now see that Fred is actually costing us £52,000 pa and Susan £55,500. We will call these our "Production Staff".

2) Now do the same for the partners (your salaried partners will have appeared among the other salaries but equity partners will not have). For each, allocate a notional salary. This may be the profit share they enjoyed at the last year end, their current drawings, or even the kind of salary level that you might have to pay if one was to leave you and you had to find senior solicitor of similar experience and ability to replace them. It is really up to you how you value them - any of these methods has logic to it. Then do the same as far as further costs are involved, including something for such as cars, personal insurances paid by the practice, pension contributions and so on but of course not allowing for employer's NI as they are taxed differently. Again, work out the true cost of having them in the firm, including their immediate support, usually their secretary. In practical terms these are also production staff but for this we will call them simply "Partners".
 
Note: Don't worry about getting these figures accurate to the last penny. We are planning here, not doing accounts. And check with your staff. If Jill reckons she really spends two-thirds of her time on Fred's work adjust her allocation accordingly.

3) Draw up a list of your departments and under each list the Partners and Production Staff, often headed by a partner, and each with the true total costs you have calculated at 1) and 2).

4) Alongside each, enter their last 12-months bills delivered figures, net of any bad debts (and, of course, not including the VAT). Now - Bingo! We have our first key indicator. Fred above has cost the firm £52,000 but billed £122,000. He therefore made a gross profit of £70,000. When you add all of Fred's colleagues in his department you will have the total contribution being made by Conveyancing. Likewise for each other department. These "profit" figure ignore the other general operating costs but they are an important first indicator. I have come across FEs that were actually making a gross loss, i.e. costing the firm more than they were billing (and, of course, making no contribution to overheads whatsoever)!

5) Now to overheads and the calculation of net, or true, profit. Go back to your last set of annual accounts. Take the total bills delievered figure and deduct (a) your net profit figure, and (b) your total costs that you came to for Production Staff in 1) above. Ignore the partners and other staff at this stage. The balance you are left with represents your total operating costs or overheads. It includes non- productive support staff and has swept up all your other costs, including such things as bank interest and so on. Divide this by the number of fee earning staff including partners and you will have a figure for the overhead share that each has to carry. For many firms it will be in the range roughly between £30,000 and £50,000 each. Remember to pro-rata this for part-time staff - it is hardly fair to stick them with a full share if they only work 3 days per week.

6) Armed with this figure, now add a further column to your gross profit schedule. Deduct from the gross figure for each fee earner their overhead share and you have their net profit contribution. In our example, if the overhead share came to £45,000 per FE, Fred Conveyancer has produced a net profit for the firm of £25,000, whereas Susan Family, who billed just £90,000 and so made a gross profit of £34,500 has produced a net loss of £10,500. She has contributed something to overhead but not enough to meet her proper share, and she has added nothing to profits. As with the gross profit calculation at 4) you can now summarise these totals for individuals, for departments and for the firm as a whole, but do remember that in these figures you have included the cost of your equity partners, which would not have appeared in your annual accounts. The overall net profit here will be lower than the net profit in your accounts by exactly that total.

Now we can really see what is going on. Believe me, it is entirely normal to be quite shocked by these figures when you do them for the first time. Partners tend to say things like "Well, we knew that Dept. A was not doing too well, but we had no idea it was as bad as that!"

With this information you can tackle the real issues. Departments that are performing badly will need some serious attention and maybe a complete re-think as to how they should operate if their performance is to be turned around, and individual FEs may need the same. After all, do you really want good profits genrated in some areas to be frittered away in others?

You can, with the appropriate figures, do this exercise monthly, quarterly or annually. Once it is running, a monthly schedule is quick and easy and a very good way to keep on top of things.

Once you are familiar with these analytical techniques you can begin to refine your methods. If you have significant work in conveyancing or in probate you may well be running high Client Account balances which in turn may be bringing in useful amounts of interest. Rather than see these go in simply as a reduction in general overhead costs, it would be more accurate to allocate them (the net amounts, that is of course, after clients have been paid what they are due) to the departments that give rise to them. They are, after all, a hidden benefit of such work. Look too for any other refinements that may be appropriate. You may have a partner that spends much of his time on managing the firm. He may only spend 40% of his time earning fees and if so perhaps only 40% of his cost should be allocated to his department, the other 60% going into general overheads. Remember too that his overhead share will need adjusting similarly. You might also look at your PI premium. Property work gives rise to premiums at the top end of the scale, whereas for crime they are very low. To get a more accurate set of figures it could be a good move to make an adjustment to reflect this. Major software and library costs may also figure. You don't need to work this to the very last penny but obvious variations between departments, when they are significant, should be reflected.

It is often said that good management is all about having good information. With this you are now in a far better position to work on the firm and its strategy.