Measuring Law Firm Profitability by Mark Dormer

Many law firms measure their own profitability by a simple net income to revenue percentage.  Although an important statistic, this can miss important factors contributing to the profitability of your firm.  For example, a firm with a high associate to partner ratio, may have a low income to revenue ratio due to associate compensation and other costs.  Firms with a strong solicitor’s practice may require more staff, and would then have a higher overhead component than a litigator’s practice.

When reviewing a firm’s profitability, we usually focus our analysis on revenue, and review the following key areas:

Revenue on a Billing Basis
This is the most common method of measuring revenue.   Most accounting programs produce internal statements on an “accrual basis”, or fees billed basis. 

Revenue on a Production Basis
Many firms do not place very much importance on production and Work in Process (WIP).  When reviewing your billings, if you have reduced your WIP from the beginning of the year, you may experience an increase in profit on a billings basis as a result of prior dated time billed in the current period.  Your fee revenue may be less in subsequent years as a result.  Similarly, an increase in WIP may reflect lower revenues until the time is billed out.  Often accountants will produce financial statements with WIP revenue and WIP on the balance sheet.  In this case, your financial statements are prepared on a “production basis”.

When your WIP is consistently climbing, you should review your billing system and cycles to ensure your fees are billed at an appropriate time.

Revenue on a Cash Basis
The flow of cash is critical in any organization.  Law firms are unusual in that many firms collect fees after performing a service.  An increase in accounts receivable suggests a firm should review their retainer and collection policy to facilitate client payments. 

Most of a firm’s expenses will show in salaries and salary related expenses.  A staff review to ensure you have adequate and skilled staff contributing towards production will confirm if you staff level is appropriate.  Often, a firm can realize additional leverage by introducing a docketing initiative for the legal staff to gain some additional leverage from staff resources.  Often your legal staff is providing value added services that is not being billed to clients.

Rent and other occupancy costs is often a distant second for costs.  Make certain you are using your space effectively.  If you are not using all your office space, plan to fill empty offices with producing associates.  Another option can be to sublease empty offices to assist in deferring some of the rental costs.

All firms should prepare a revenue and expense budget for the upcoming fiscal year.  This is a great opportunity to review all expense items and plan for spending for the coming year.  Actual expenses should be compared to budget on a consistent basis.

Measuring Profitability

A key performance indicator we use for measuring the profitability of your law firm is Net Income per Partner (NIPP).  If you have non-equity, or income partners in your firm, you may want to exclude them from this exercise.  If that is the case, then their compensation should be notionally added to the firm expenses.

Your NIPP will give you a good indication your profitability, especially if you compare the NIPP on a billings, production and cash basis.  You may also want to review this figure as a percentage of partner billings, and NIPP in prior years.

Performing all of the above review and planning will indicate financial areas within your firm that requires attention and planning, and give you a better understanding of the financial health of your law firm.

Interim Managers vs. Consultants by Catherine Moffitt

Recently I was struggling to find a way to describe to a colleague my role as Interim Manager to law firms and how it differs from being a consultant.  I recalled an article from September 20, 2010 in Canadian HR Reporter written by Sarah Dobson, entitled: “Use of Interim Managers an escalating trend” which accurately reflects my experiences.
Ms. Dobson compares the benefits of engaging an Interim Manager over a Consultant when an organization needs help to maintain daily operations, get through change or when they have a gap in manpower. 
So what’s the difference between an Interim Manager and a Consultant?
Interim Managers:
  • Typically like to share and help develop people
  • Attend on a regular basis and become a familiar face
  • Contribute towards routine operational management of firm allowing partners and business owners to focus on client work
  • Are hired to execute and implement
  • Become part of the management team and firm culture, often leading the initiatives
  • Provide a stabilizing effect – keep the peace
  • Bring fresh ideas and approaches to solutions and move things forward
  • Share their knowledge and experience of other firms
  • Able to remain candid and avoid the constraints of office politics
  • Encourage and facilitate confronting issues within firm and hold people accountable
  • Provide experienced, senior management expertise on a flexible part-time basis to handle the needs of small to mid-sized firms that lack the budget for in-house staff
  • Generally only hired to make an assessment and report on it
  • Don’t typically implement and are not hands-on
  • Are not generally strong operational people, more of an advisory role
  • Often charge 2-3 times more than interim talent who are paid part or full time
  • Don’t typically  reside in your environment to appreciate the culture and daily pulse
Keeping up with today’s fast business pace is difficult.  Often in-house resources are already overstretched just attending to client business.  This results in the day-to-day operations, such as facilities maintenance, human resources issues and administrative processes, getting put aside until it either becomes a major problem or until the manpower and financial resources become available to address them.
Incorporating an Interim Manager into your firm can be a cost effective way of managing these ongoing operational issues, enabling lawyers and their staff to get on with practicing law.

Small-firm practices can be highly profitable

Maintaining a healthy level of profit in a small or sole-practise law firm can be tough, and there’s no magic bullet for success. In fact, sometimes your first instincts can lead you astray.  “Quite often, if someone thinks they should do something to improve their bottom line, they should do the exact opposite,” says Wayne Cosgrove, a profitability consultant with Cosgrove & Associates in Toronto who specializes in working with small law firms.

For instance, the first reaction to a shrinking profit margin might be cutting expenses — but Cosgrove often advises his clients to actually increase office expenses. “What are you going to do, cut your staff, which you need? Cut staff salaries? You can cut till the cows come home, and even if you’re successful in saving some money, it won’t make much difference on the bottom line,” he says.

Instead, he recommends investing in a modern office, in trained and competent staff, and in good computer software and hardware. “Without that, there’s not much use in trying,” he advises.  “You have to make sure your office is refurbished every so often, your staff is trained in the latest information, and your technology is up to date.”

Here are eight of Cosgrove’s tips for improving profits:

  1. Focus on files.  Stop reacting to crisis after crisis, and move your current files to their conclusion.
  2. Docket your time meticulously.  Send a bill as soon as the job is done - don't wait for the end of the month.
  3. Collect retainers, and replenish those retainers whenever needed.
  4. Draw up a monthly "profit plan" showing what's coming in, what's been written off, and what bills must be paid.  With foresight, you can spot and plan for trouble.
  5. Raise you billing rates annually.
  6. Train staff to multitask, so that assistants double as bookkeepers, or even paralegals - and compensate them accordingly.
  7. Form partnerships with younger lawyers who can eventually take over the bulk of the firm - and avoid partnerships with those who will wind down and retire when you do.
  8. Market yourself.  Instead of lunch or drinks, visit your client's firms and get to know their business better.  You'll be amazed at how pleased they'll be.
Amy Jo Ehman

Reprinted with permission from the Jan/Feb 2005 issue of National, the magazine of the Canadian Bar Association.  Copyright 2005.

Marketing Basics for Associate Lawyers by Catherine Moffitt

In my experience with law firms, it is quite common to come across new associates who have had very little training in law school on how to market themselves. Oftentimes they are simply intimidated by the concept, don’t know where to begin and thus rely on senior lawyers to provide them with work.
In order to build a successful law practice, new associates need to begin early on in their career to develop strong practice management skills, along with integrating some very basic marketing activities into their daily routine.
Basic Marketing Tips:
  1. Create a “Marketing” file and keep it in an accessible location.
  2. Docket your marketing time under a non-billable code to keep score of your efforts. Most law firm accounting programs can track revenue by source allowing you to focus on successful initiatives.
  3. Develop a brief, simple statement that describes what you do and where you work (elevator speech).
  4. Make a list of all the people you think could be influential in helping you gain more business, including: peers, friends, previous employers, family, religious leaders, medical or financial professionals, politicians, educational authorities, health care practitioners, focusing on contacts who will generate the kind of clientele you hope to work with.
  5. Decide the most comfortable means for you to connect with potential new business contacts: writing articles, social media, speaking engagements, charity sponsorship, networking associations, coffee or lunch, emails, newsletters, sporting events, etc.
  6. Keep a current database to record and track your contact information and activity.
  7. Join professional associations, volunteer in your community, attend firm-related events.
  8. Set goals for yourself and schedule your marketing activities in advance. Attempt to network with at least one contact a month and do one other marketing event o four choice each quarter.
  9. Always follow-up with a “thank you” phone call, email or card to any referral sources.
  10. Consider working with a coach to assist you in developing a basic marketing plan that suits your particular skills and interests, and help keep you on track.
  11. Don’t give up!
    • Don’t expect to get something in return.
    • Look for ways you can learn more about your contacts and open dialogue on topics of interest.
    • Build trust and keep in touch with your contacts.
Marketing does not have to be complicated.  Following these basic tips early on in your practice will help you develop confidence and long-term habits in building a clientele base for a successful practice.

Managing Associates – A Key to Profitability by Wayne Cosgrove

When we work with law firms, our goal is to help them improve their profitability. The question partners most often ask us is “how do we manage associates”.  Our response is simple. You don’t. You teach them to manage themselves.

As we see it, partners in a law firm have two main roles – to manage their own practices and to provide leadership within the firm. The problem is, many partners don’t have the time or patience to teach practice management to new associates. In many cases they’re left on their own.

Some of the larger firms have professional managers who develop and manage internal practice management training. Often it is integrated with new lawyer orientation.  Over the years larger firms will likely have developed guidelines for docketing, billing and collection practices which are communicated to and understood by the associates. There’s usually some direct or indirect pressure applied for compliance.

Smaller firms don’t have the luxury of a budget for hiring this type of expertise, so they may have to turn to external resources such as practice consultants for help. While lawyers are accustomed to providing advice for their clients they often resist seeking external assistance for themselves.

This is no simple challenge. The Third Edition of Compensation Plans for Law Firms of the Law Practice Management Section of the American Bar Association, reports that “the typical first full year for an associate usually is an investment for the law firm.  By the end of the third year that investment is nearly recovered.” We have no reason to believe experience in Canada is any different.

There is often a high turnover in associate ranks resulting in a continuing lack of profitability of associates.  That high turnover rate can negatively impact the growth of the firm.  Partners need to know they must become good leaders for associates.  In turn, associates must understand that they must take charge of their own practice management and their own development.  And they need to know what is expected of them, not only in practice management but in other areas as well.  It is important to involve them in setting their vacation schedules and docketing targets which translates into monthly and annual billing targets.

Successful associates will seek out partners who exhibit good practice management skills. They will emulate them and avoid picking up the habits of partners who are not strong in this area.  They must seek out help on practice management issues if not presented to them.

Profitability is about cash flow and cash flow is largely about time management.  Associates need to familiarize themselves with the firm’s accounting system and reporting to monitor their own progress on a daily, weekly, monthly, and annual basis.

It all starts with docketing time.  Most legal accounting systems have an effective time docketing system.  Although the system should sometimes be a costing system rather than a billing system, the capture of time, both billable and non-billable time, is critical to good practice management.  Good habits learned early will pay rich rewards throughout a career.

There’s also the matter of billing of fees.  Work In Process (WIP) is one of the key “pools of assets”, which associates must learn to manage.  Often this is left to the senior partners of the firm. For their own files, associates need to adopt an effective system of billing.  Most often there are pressures on lawyers to bill each month-end but such a system of billing combined with “by the week” billings will be more effective.

Finally collections.  Why work for free?  Associates need to learn early on the importance of retainers.  In some firms, lawyers are successful at getting original retainers but have not developed an effective system of replenishing the retainer.  Where a retainer will not be obtained it is important that the firm have an effective credit approval process as well as a dedicated person to coordinate the collection process.

In the area of compensation an associate must know how the compensation scheme works. Compensation may not motivate associates to produce, but lack of it can demotivate them. New associates, with little control over billings or collections, should know what they are going to earn.  In those cases any year-end bonuses may best be discretionary.

As time goes by associates will generally relate compensation to fees collected.  Simple formulae may cause self-centred behaviour.  As they move towards partnership the same values the partners use for profit sharing should be introduced to associates.

The partners should take steps at the outset to continually integrate associates into the firm.  That would include mentoring, coaching, and involving them in the firm’s planning retreats and monthly meetings. They should be provided with the criteria for partnership.

Firms who have seriously adopted this approach - of keeping their associates in the know - have been successful in achieving more rapid associates’ profitability, sometimes in year one.