27 July 2022 Mini Series: The Business of Law Firms - Comparing Profit Margins

Mini Series: The Business of Law Firms​

Comparing Profit Margins​

Overview

Welcome to the fifth article in our series on the Business of Law Firms.

Last week, we looked at the overall purpose of the income statements and their usefulness in calculating a business's profit margins. We calculated Clifford Chance’s profit margins in two ways: operating profit margin and net profit margin.

Today, we will look at net profit margins for other law firms and consider the use-cases and limitations in comparing the figures.

Net Profit Margin

A business’s net profit margin gives us a sense of how efficient it is in taking in cash and generating a surplus. We can calculate the net profit margin by first deducting all expenses from the business’s net sales and then dividing the difference by the net sales. We convert this figure into a percentage to arrive at the net profit margin.

For Clifford Chance, its financial year 2021 net profit margin is as follows:

£1,828-£1,189
£1,828 = 0.3496 x 100 = 34.96%

In other words, for every £1 Clifford Chance brings in, it can generate an extra 35p in profit.

The higher the percentage, the more profitable the business is. To the business’s senior management, the net profit margin is a useful proxy for determining the efficiency of the business. To improve the margin, management will need to either improve the volume of sales (or increase prices) or cut down on expenses.

Comparing Profit Margins

Profit margins can also be used to compare performance across different businesses in the same sector.

Below is a table with figures pulled from certain law firms’ financial year 2021 accounts with the net profit margin calculated at the bottom of each column.*

Table 1 - Financial Year 21 Net Profit Comparison**


*Ideally, we would have liked to use the figures many firms have recently released through to April 2022. However, because these figures are not disclosed in the firms’ annual accounts, we cannot refer to the underlying data (such as expenses and how they are calculated).
**These figures are approximations and presented for illustrative purposes. Expenses include operating expenses, net finance costs, tax, and any partners’ remuneration charged as an expense, but not other accounting treatments. Some firms provide more information in their accounts compared to others, which means these figures are not perfectly comparable. In practice, accountants have ways of standardising figures more accurately than the numbers given here.

How is this relevant for my interviews?

If you are comfortable with the basics behind important financial performance metrics like net profit margin and other income statement figures, interviewers will be confident in your numeracy and commercial skills. Additionally, it can be useful to apply these skills when evaluating why the firm you are interviewing with is excelling compared to its competition, by making specific reference to its financial performance.

The key is being able to integrate the numerical analysis within the wider commercial context. This means going beyond simply listing off client revenue (net sales), net profit, and profit margin. What exactly has Clifford Chance done to arrive at a comparatively higher profit margin compared to, say, Freshfields? Does this profit margin tell the whole story? In Freshfields' case, in the financial year 2020 and financial year 2021, it invested heavily in its US market presence, which may have artificially reduced its profits (because of higher-than-usual expenses).

In other words, the income statement figures only tell part of the story. To understand the wider picture, you might consult with updates released by law firms, along with third-party articles.