Managing the Law Firm’s Balance Sheet for Future Profit

Most law firms are run by the numbers: This year’s numbers. Afterall, “At the end of the year, my PPP must be bigger than your PPP.” While this measure is fine for reporting to the legal press, current year profit per partner is a poor management tool. This is because PPP is no indication of whether the firm can sustain its profits long-term, just as current year earnings per share are no indication of future profitability for a publicly-held company. Future profits come from the management of invested resources, and the most significant invested resource in a law firm is its Intellectual Capital (IC).

Since intellectual capital does not appear on a balance sheet (and profits on it do not clearly appear as a part of PPP), IC is often managed poorly — if at all. Because IC is intangible, finance directors and managing partners view it with suspicion. We suggest that this suspicion is misplaced and outdated. Like it or not, law firms are managed more and more like businesses. In particular in Europe, a firm’s ability to manage its intellectual capital effectively will soon be at the top of every managing partner’s mind. When the Clementi reforms take effect in the United Kingdom (anticipated in 2008) and eventually across Europe, non-lawyers will be allowed to own or invest in law firms. Law firms will be able to attract venture capital and private equity investments. Invariably, financial investors will be keen to invest first in those firms that manage their resources best — and a firm’s primary resource is its intellectual capital. In the meantime, the wisest firms will seek to increase PPP by managing IC using financial and non-financial indicators. In this article, we explain how to do this.