Profit sharing structure
This is the one area that can cause the most disharmony in professional practices. In modern times, as practices become more business-like, it is good practice to adopt a more corporate approach and one we often recommend includes:
Interest on Capital
An agreed, commercial rate of interest on partners’ capital. This should be paid monthly and should cover both fixed and current capital accounts and assists partners to borrow capital from their bank.
Fixed share payment
Better described as a notional salary payment. This should be an agreed rate as reward for the management roles that the partners play in the business. It should be paid monthly, after deduction of estimated tax/NI and gives both the business and the partners a degree of predictability of cashflow. It is also an important component for deriving the partner hourly charge-out rate for billing and costing.
The level set must be realistic, so that there is no risk of overdrawing the forecast profits of the business over the accounting year. Consequently, profit performance must be kept under regular review.
Potentially the most contentious element, but a necessary mechanism to reward the highest performers in the business. It demands a SMART objectives based appraisal system in order that it is seen to be fairly distributed and could perhaps be set at about 10% of the profits remaining after interest on capital and notional salaries.
A simple mechanism to adopt is splitting the pool into thirds and applying these against three areas of performance – individual, departmental and whole firm. Performance is then measured against hard facts, according to criteria set out at the beginning of the year. The main criteria suggested are:
- Chargeable hours
- Management of lock-up (WIP & Debt)
A payment to partners of residual profits based on underlying ownership.