Law firms are pretty simple businesses! Conceptually, law firms sell their fee earners’ time. As such, you can think of that fee earners’ time as the firm’s raw material, much like cloth is the raw material for clothing companies. Now, in practice, law firms enter into various fee arrangements with clients, ranging from "time spent" fees to capped or fixed fees to conditional fees. It all goes back to time, though: (an estimate of) the required fee earners' time underpins most of those arrangements.

Most businesses come down to the concept of ‘buying low and selling high’ - and law is no exception! Fee earners’ charge out rates are (often much!) higher than their hourly wages. The difference between fees earned and fee earner salaries is called gross profit (gross margin, a sibling term, denotes gross profit as percentage of revenues).

Gross profit is then used to pay for the operation supporting fee earning activities - think business services teams, premises, marketing, etc.. Whatever remains is called ‘operating profit’. That can be used to pay interest on debt (if any) and the remainder distributed to the tax authorities and the partners. Note that equity partners usually don’t draw salaries and instead rely on profit distributions. Available profit divided by the number of equity partners produces the famous profit per partner (PEP) metric.

Thanks to the wonders of modern accrual accounting rules, showing revenues and profits is not tantamount to generating cash. In fact, there is usually a significant disconnect between accounting results and cash flow. There are good arguments for that, by the way! It just means that assessing a law firm’s financial health is a more nuanced exercise.