- Date
- 20 July 2022
Mini Series: The Business of Law Firms - The Income Statement
Mini Series: The Business of Law Firms - The Income Statement
By Jake Rickman |
Overview
Welcome to the fourth article in our series on the Business of Law Firms.
Last week, we looked at why law firms deduct a portion of their profit as expenses. Today we will look at the overall purpose of the income statement and how we can use the information to analyse a law firm’s performance.
Accounts: Measuring Profits
We will continue to use Clifford Chance’s most recent accounts, with its income statement copied below.
| Year ended 30 April | 2021 (£m) | 2020 (£m) |
| Revenue | 1,828 | 1,803 |
| Other operating income | 3 | 3 |
| Operating costs | ||
| Staff and related costs | (822) | (802) |
| Other operating costs | (300) | (319) |
| Operating profit | 709 | 685 |
| Net finance costs | (17) | (22) |
| Profit before tax and members’ remuneration and profit | 692 | 663 |
| Members remuneration charged as an expense | (30) | (8) |
| Profit before tax available for profit share among members | 662 | 665 |
| Taxation | (20) | (18) |
| Profit for the financial year available for profit share among members | 642 | 637 |
| Total Comprehensive Income for the Year | 626 | 621 |
The Income Statement
The figures on pages 10-11 in Clifford Chance’s accounts measure the firm’s profitability for the accounting period between 1 May 2020 and 30 April 2021. For all businesses including law firms, the goal of an income statement is to tell the reader how profitable the firm’s business is. That is, after deducting expenses from all the money brought in from the firm’s business, how much is left over?
By delineating different measures of profit (e.g. operating profit versus profit net of tax), analysts can calculate a business's profit margin.
Just like we can measure profit in different ways, profit margins come in different flavours. There are two important measures of profit margin for law firms:
- Operating profit margin
- Net profit margin
As we looked at previously, operating profit measures all the income less all non-finance and non-tax expenses. To calculate the operating profit margin, we need to calculate the operating income and divide this figure by the firm’s total revenue (and then convert it to a percentage).
In Clifford Chance’s case, this figure is:
£709
£1,828 = 0.3862 x 100 = 38.62%
For all businesses, the operating profit margin is a useful tool to determine how much money is available to pay down their debt. For investors looking to acquire a business, calculating a business’s profit margin gives them a rough idea of how much money the company can borrow to fund the cost of acquisition. This is because this figure represents the potential cash available to service the debt (i.e. interest payments). The higher the margin, the more debt the business can take on, which may increase the potential return on investment. In this context, investors refer to operating profit as EBIT, or 'earnings before interest and tax'.
Of course, law firms are rarely the target of large acquisitions. But all the same, its operating profit margin gives a quick indication of the raw profitability of the business.
Net Profit Margin
Net profit is the “bottom line” figure. That is, how much cash is available to the partners after all expenses are calculated. To calculate the net profit margin, we simply subtract all expenses from the net revenue, including interest and taxes. We then divide this amount by the net sales and convert the figure into a percentage.
For Clifford Chance, this figure is calculated as:
£1,828-£1,189
£1,828 = 0.3496 x 100 = 34.96%
Expressed as a percentage, net profit margin allows us to evaluate the profitability of one firm relative to others.
We will look at comparisons between law firms next week!
