In order to manage your law firm’s financial performance effectively, it is necessary to focus on those economic issues that have the greatest impact. These issues can be categorized into four general areas:
- Production Issues
- Cost Structure
- Inventory Management
- Balance Sheet Structure.
Although excellent legal work and client service are always necessary, your financial performance is driven in many respects by your ability to control these four important areas.
Production is affected by four key areas: leverage, fee production, capacity utilization and pricing or billing rate.
Leverage is the function that drives most law firms’ profitability. It is a measure of a firm’s ability to assign work to the correct level of expertise needed to serve the client. Clearly, the more commodities-like the work is, the higher the leverage should be.
Fee Production is a firm’s ability to ensure that timekeepers are producing. This is usually driven by the firm’s ability to hold its attorneys and other timekeepers accountable for meeting specific revenue targets.
Capacity Utilization measures how effectively the firm uses its attorneys and timekeepers. Although most firms use billable hours to measure this, hours are simply a tool for cost accounting and revenue forecasting. Billable hours measure management efficiency rather than being an end in them. Capacity utilization adds the benefit of also focusing on non-billable time.
Billing Rates remain critical because most work is still priced by the hour. Setting your rates within your market can be more art than science. However, management may want to explore various types of alternative fee arrangements that will increase profitability.
Although top line revenues remain critical, focusing on cost also can help firms manage their efficiency. When looking at cost, three areas need to be considered: staffing levels, compensation levels and occupancy costs. Additional costs that can be observed are discussed below.
Staffing Levels. Without question, staffing levels, especially for secretarial and support services, need to become much leaner in most law firms. Our experience has been that many firms truly benefit by a frank and honest discussion of necessary staffing levels. We work with firms to achieve and then maintain appropriate lawyer-to- staff ratios.
Compensation Levels. Many believe that the abilities to attract quality individuals and maintain loyalty surely are driven by compensation levels; however, that is beginning to change. Escalating salaries for new hires are beginning to level off as employees seek additional benefits less related to monetary concerns. A prudent evaluation of compensation levels for staff can be the most important move firms make to consider the impact of their cost structures.
Occupancy Costs. Other than salaries, occupancy costs tend to be a firm’s second largest expense. Furthermore, it is often the case that this is an uncontrollable cost, often driven by ego rather than by prudent decision making. Achieving occupancy costs below 10 percent of revenue is a goal for which all firms should strive.
Other costs, including technology, library and research materials and marketing need to be examined continually to ensure that the greatest benefits are being achieved. Interestingly enough one of the largest costs in this area is related to partner involvement. For example, removing partners from the purchasing decisions for office equipment and technology can free up time for billable work.
When we work with law firms, one area we focus on is the concept of managing inventory. Otherwise known as billing and collections, inventory management is critical to the success of your firm. The most important element in this examination is the time lapse between when work is done and when your firm is paid. By speeding up billing and closely monitoring accounts receivable, firms can increase their realization rate and decrease their need for external capital. Too many firms focus on billing while neglecting the more important concept of getting paid. We help firms focus on their realization rate to help increase profitability.
Balance Sheet Structure
Capital is necessary to run all businesses, even law firms. Employees need to be paid, office equipment needs to be purchased or leased and all too often these concerns need to be taken care of before we collect our receivables. Traditionally, capital has come from two major sources: partners and banks. In today’s banking environment, we find it more likely that partners need to sign guarantees or pledge firm assets – or both – to ensure funding. Many firms choose not to secure bank financing to increase their capital basis. Rather, they rely on their own resources to do so. The most successful firms continually add to their capital base to help ensure their long-term success.
Although we have briefly described the four critical areas to help increase your firm’s financial performance, an excellent opportunity awaits those firms who are willing to implement and monitor the correct financial performance programs to increase profitability. We work with law firms to help them achieve their financial goals through proper financial management. If you are interested in learning more, please contact our office.