Understanding Law Firm Financials: Making the Numbers Work

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Practicing law is not just about client files and research, but also defining the value of your legal services. Too many lawyers let their businesses suffer, failing to understand the finances of their files. Learn how to measure your firm’s worth, so that your billing and accounts meet your needs and your client's expectations in this session on tracking legal account receivables.

Join Colin Cameron, CA, Founder of Profits for Partners, Management Consulting Inc. and Joshua Lenon, Clio's Lawyer in Residence as they discuss:

- How keeping your firm solvent is an ethical obligation
- What financial measurement tools law firms are using
- What key financial performance indicators are critical for
your practice

Published in: Law

Understanding Law Firm Financials: Making the Numbers Work

  1. 1. Understanding Law Firm Financials: Making the Numbers Work Joshua Lenon – Clio Colin Cameron - Profits for Partners
  2. 2. Agenda •  Ethics of Law Firm Finances (10 minutes) •  Financial Measurement Tools for Law Firms (10 minutes) •  Key Performance Indicators (30) •  Questions (10 minutes)
  3. 3. Instructors Joshua Lenon •  Lawyer, admitted in New York •  Lawyer-in-Residence for Clio Colin Cameron, CA •  Chartered Accountant •  Former Chief Operating Officer of Clark Wilson LLP •  Profits for Partner
  4. 4. ETHICS OF LAW FIRM FINANCES
  5. 5. Source:(The(Lawyer,(01/17/2014(
  6. 6. Source:(Business(Insider,(06/24/2012(
  7. 7. Source:(Globe(and(Mail,(02/07/2014(
  8. 8. How you run your law firm affects your clients.
  9. 9. Lawyers have been having difficulties with finances since the Boer War in 1901. Source:(RighCng(Wrongs:(The(Missouri(Bar(Client(Security(Fund,(( Precedent,(Winter(2011(
  10. 10. Model Rules of Professional Conduct •  Rule 1.1 – Competence •  Rule 1.3 – Diligence •  Rule 1.5 – Fees •  Rule 1.15 – Safekeeping Property •  Rule 5.4 – Professional Independence
  11. 11. Rule 1.1 – Competence A lawyer shall provide competent representation to a client. Competent representation requires the legal knowledge, skill, thoroughness and preparation reasonably necessary for the representation.
  12. 12. Emerging Tech Proficiency “It should now be a matter of professional competence for attorneys to take the time to investigate social networking sites.” Griffin v. Maryland, Case No. 1132, Court of Special Appeals Maryland, May 27, 2010,
  13. 13. Self-Interest & Competency “…there is little meaningful distinction between a lawyer who inadvertently fails to act and one who for selfish reasons decides not to act.” Beets v. Scott, 65 F.3d 1258 (C.A.5 (Tex.), 1995)
  14. 14. Rule 1.1 – Competence Competent handling of a particular matter includes inquiry into and analysis of the factual and legal elements of the problem, and use of methods and procedures meeting the standards of competent practitioners. It also includes adequate preparation.
  15. 15. Rule 1.3 – Diligence A lawyer shall act with reasonable diligence and promptness in representing a client. [1] A lawyer should pursue a matter on behalf of a client despite opposition, obstruction or personal inconvenience to the lawyer… [2] A lawyer's work load must be controlled so that each matter can be handled competently.
  16. 16. Rule 1.5 – Fees (a) A lawyer shall not make an agreement for, charge, or collect an unreasonable fee or an unreasonable amount for expenses (3) the fee customarily charged in the locality for similar legal services;
  17. 17. Rule 1.5 – Fees [5] An agreement may not be made whose terms might induce the lawyer improperly to curtail services for the client or perform them in a way contrary to the client's interest. … However, it is proper to define the extent of services in light of the client's ability to pay. … A lawyer should not exploit a fee arrangement based primarily on hourly charges by using wasteful procedures.
  18. 18. Rule 1.15 – Safekeeping Property (a) A lawyer shall hold property of clients or third persons that is in a lawyer's possession in connection with a representation separate from the lawyer's own property.
  19. 19. Rule 5.4 – Professional Independence (d) A lawyer shall not practice with or in the form of a professional corporation or association authorized to practice law for a profit, if: (3) a nonlawyer has the right to direct or control the professional judgment of a lawyer.
  20. 20. Ethical Conclusion Lawyers are responsible for preparing their practices’ finances to be ready to handle a reasonable workload.
  21. 21. FINANCIAL MEASUREMENT TOOLS FOR LAW FIRMS
  22. 22. Practice Management Tools
  23. 23. Full Accounting Suites
  24. 24. Legal Accounting hIp://gocl.io/legaccweb(
  25. 25. Understanding Law Firm Financials - Making the Numbers Work Clio Webinar – May 28, 2014 Speaker: Colin Cameron President, Profits for Partners, Management Consulting Inc. May 28, 2014
  26. 26. Today’s Agenda •  Trends in the legal industry •  White papers on Realization Rates and Alternative Billing •  The 5 Levers of Profitability •  Key profitability metrics •  Strategies for increasing profitability 28
  27. 27. 5 Major Trends Impacting Law Firms Today 29 Realization rates are dropping Clients demanding discounts Alternative billing Focus on efficiency Rise of NewLaw business models
  28. 28. How is Profitability Calculated? 30
  29. 29. The 5 Profitability Levers •  Utilization = Billable hours / # of Lawyers •  Standard Hourly Rate •  Billing Realization Rate = Billings / Value of Time Recorded at Standard Rate •  Margin = Net Income / Billings •  Leverage = # of Associates / # of Partners - David Maister, “Managing the Professional Services Firm” 31
  30. 30. Utilization •  The “Pipeline” 32 flickr.com/photos/jkbrooks85/5588292846
  31. 31. Utilization •  Utilization = Billable hours / # of Lawyers e.g. 120 billable hours / 1 lawyer = 120 hours •  Utilization rate = Billable hours recorded / Available time e.g. 6 billable hours / 8 available hours = 75% •  # of files opened •  # of new clients 33
  32. 32. Track Time for Alternative Billing? •  Yes! •  Most hourly billing metrics still apply •  Time and billing system features available •  For costing and pricing purposes •  Profitability analysis 34
  33. 33. Rates •  Effective Rate = Billings / Billed hours e.g. $20,000 billings / 120 billed hours = $166.66 effective rate •  Firm effective rate •  Small rate increases produce big bottom line gains •  Partner effective rate •  Client effective rate 35
  34. 34. Focus on Value •  Need to decide value before you set price •  Compete on value, not price •  Ron Baker’s ideas •  Value = Client “Profit” – Price •  51 Practical Ways to Add Value 36 Colin Cameron – Profits For Partners
  35. 35. How do you define Value? •  Quantitative factors •  Qualitative factors •  Ask client how they define value •  Client decides value, not lawyer * •  Client satisfaction •  Efficiency •  Effectiveness 37
  36. 36. The Economics of Alternative Billing •  A 20% discount with 40% profit margin = 50% cut in profit •  Leverage still works •  Need to get more efficient •  Realization is key to profitability 38 Colin Cameron – Profits For Partners
  37. 37. Realization •  $20,000 billings / $24,000 value of time billed at standard charge-out rate = 83.3% Billing Realization Rate •  $18,000 cash in / $20,000 billings = 90% Collection Realization Rate •  $18,000 cash in / $24,000 value of time billed at standard charge- out rates = $75% Overall Realization Rate 39
  38. 38. Realization - Strategies •  Upgrade your clients •  Run realization reports for all clients •  Focus on cash in as a % of prebill •  Use an 80% realization cut-off •  Aim for 95% realization 40 flickr.com/photos/gageskidmore/5440002785
  39. 39. Margin •  Margin = Net Income / Billings e.g. $80,000 net income / $200,000 billings = 40% margin •  Net profit margin % •  Overhead per lawyer •  Overhead as a % of revenues •  Compare expenses to legal industry surveys 41 Focus on increasing productivity as well as reducing costs to increase margin
  40. 40. Margin •  WIP Turnover = WIP / Average billings per month or day •  A/R Turnover = A/R / Average Billings per month or day •  Lock-up = WIP Turnover + A/R Turnover •  Run reports monthly by Partner •  Aim for 105 days/3.5 months or less 42 flickr.com/photos/revstan/48501 93874/
  41. 41. Margin - Strategies •  Drive cash flow and reduce bad debt expense •  File opening approval system •  Monthly billing •  Bill and collect everything on quarters •  Quarterly income distributions 43
  42. 42. Margin Strategies - Reduce Costs •  Virtual firms •  Outsourcing staffing •  Contract lawyers •  Automate for efficiency •  NewLaw business models cut O/H by 50% 44
  43. 43. The Power of Leverage •  Leverage = # of Associates / # of Partners e.g. 7 associates / 3 partners = 2.3 leverage •  Leverage can have the biggest impact on profitability •  Consider two-tier partnership •  Increase profitability by levering work to nonequity partners and associates •  Work smarter, not harder 45 Colin Cameron – Profits For Partners
  44. 44. The reverse pyramid 46
  45. 45. Leverage •  Upright the reverse pyramid! 47 Associate to partner ratio • aim for 1:1 or higher Associates and nonequity partners to equity partner • aim for 2:1+ Lawyers and other professionals per equity partner ratio • aim for 3:1+ Associate hours / Partner hours • aim for 1:1+ Paralegal hours / Partner hours
  46. 46. Leverage •  Revenue per Equity Partner (entire practice) •  Profit Per Partner Hour – PPPH •  Work/Life balance •  See articles in Law Firm Profitability group on LinkedIn for ideas on increasing profitability 48
  47. 47. Profit Per Partner (PPP) Formula PPP = Utilization x Standard hourly rate x Billing realization rate x Margin x (Leverage + 1) PPP = 120 hours utilization x $200 standard hourly rate x 83.3% billing realization rate x 40% margin x (2.3 leverage + 1) = $26,667 PPP 49
  48. 48. The 80/20 Rule for Client Profits •  Studies show that 80%+ of the firm’s profits are produced by just 20% of your clients •  Focus on key metrics for these top 20% clients •  Review bottom 20% of clients that may have negative profitability 50
  49. 49. Summary ! Client selection is #1 ! Focus on value, not price ! Reduce costs as a % of revenues ! The power of leverage ! Update your business model ! Focus on key metrics that fit your firm’s strategic plan 51 Colin Cameron – Profits For Partners
  50. 50. Thank You! •  Questions or comments? ▫  Colin Cameron | President ▫  Profits for Partners, Management Consulting Inc. ▫  www.profitsforpartners.com (website) ▫  www.lawprofitability.com (blog) ▫  colin@profitsforpartners.com ▫  604.512.8104 © 2014 Profits for Partners, Management Consulting Inc. 52 Colin Cameron – Profits For Partners
  51. 51. QUESTIONS
  52. 52. Thank You Joshua Lenon joshua@goclio.com @JoshuaLenon Linkedin.com/in/joshualenon

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