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When you think about the function of a law firm, your thoughts probably go straight to the provision of legal services. But law practice administrators must recognize that their firms are also revenue-earning businesses that need money to operate. For this reason, it is imperative to keep tabs on financial performance. They need to know whether the firm is bringing in enough revenue, as well as whether strategies and expenditures benefit or hurt the firm.
With regular reporting and analytics, firms can track metrics that provide valuable detailed financial analysis. This blog will take a closer look at some of those metrics, including what data they provide and how often firms should review them.
As the name suggests, these reports provide a detailed look at the law firm’s finances, including how much money is coming in, how much is on hand, and how much is being spent. To gain a complete view of a firm’s financial status, administrators can consider the following financial reports:
Law firms need to keep an eye on the productivity of the firm in order to promote efficiency, cost savings, and maximized profitability. While we tend to think of productivity as the pace of work being completed, there are a number of additional factors to consider within a law firm environment:
Many law firms pour extensive amounts of money into their marketing strategies with little understanding about the effectiveness of their efforts. The following marketing performance indicators need to be part of a law firm’s regular reporting process so that administrators can evaluate what approaches are working and what needs to be tweaked:
Law firms often build their practices around a single niche or a few specific practice areas. But societal changes can result in evolving needs among potential law firm clients. For example, the pandemic brought about a surge in such practice areas as bankruptcy, health law, and employment law.
Firms should take a look at the performance of their practice areas at least annually to determine whether they are still performing at a profitable level. This data can be collected externally from legal industry reports and studies, as well as internally from practice area comparisons of new matters and revenue generation. The information can then be used to make crucial decisions about the firm’s practice area direction.
These are only examples of the numerous types of reports that help law firm administrators evaluate the viability of the practice. It’s important that administrators identify metrics that specifically speak to the health of their firms and take steps to monitor them on a regular basis. With weekly and monthly reporting, administrators can promote what is working and make timely changes to address what is not.
With the continuing change in the landscape for law firms, it is increasingly important for firms to understand where their most profitable areas of practice lie. Gone are the days of multi-generational client loyalty. As a result, firms must hone their skills and identify the areas that are most beneficial in adding to the bottom line. Regardless of how altruistic your firm’s core values are, without a profitable business, you will be unable to support your clients or your employees.
There are multiple metrics a firm can monitor to ensure financial success. Having good billing protocols is a good place to start. Once those procedures are functioning well, you can accurately identify which areas of practice are most beneficial to your firm. Knowing where you should be focusing your assets (time) allows you to strategically make decisions on what cases to accept and what cases should be declined or referred out.
Begin this process by identifying the practice areas in which your firm most often practices, and ensure they are entered into your billing system. Using a billing system that allows you to identify practice areas and run reports quickly and efficiently is an important piece of this process. The identification of practice area should be a part of your client intake protocol to ensure that cases are properly identified at the outset.
Depending on firm size, there are different ways to go about the identification of departments. If your firm typically has specific attorneys and staff working in each practice area, it is intuitive to define your departments by practice area. You may have a real estate department, a civil litigation department, a criminal litigation department, and a corporate department, for example.
If most of your attorneys are working across multiple areas of practice, you may want to define your departments by supervising attorney rather than by practice area. This will allow you to determine whether profitability is impacted by practice area or by managing attorney, for example.
Once you have identified the practice areas you want to track and how you would like to divide your billable timekeepers (attorneys and paralegals) into departments, you can start monitoring the revenue you are seeing from each practice area and department. By putting your clients into buckets of practice areas, you can:
The cost to acquire a client may be different depending on the practice area. Your physical injury cases may come to you through television advertising, which is going to have a different cost than your probate clients, who may come to you through word of mouth. By identifying your client acquisition costs by practice area, you can get a more accurate evaluation of the true profitability of each case type.
Likewise, the lifetime value of a matter is going to be different by practice area. As is the case with acquisition costs, by identifying your average lifetime value by practice area, you can drill down even further on profitability by case type.
Once you have calculated the average acquisition cost and lifetime value for your cases by practice area, you can determine an overall average net revenue for each area. This does not take into account the costs of your timekeepers or firm overhead – this is strictly net revenue after taking into account the cost to acquire the matter. For example:
Once you have calculated the net revenue by practice area, you can break things down even further to determine your revenue by department. In this calculation, you add in the direct costs of your timekeepers in each department.
To begin, you need to have calculated the hourly cost for each of your timekeepers. By knowing what it costs for each of your timekeepers to work one hour, you can calculate their costs in each practice area by running a report showing total hours billed by practice area or department. In the example below, the firm’s departments are identified by practice area:
Now that you know what it costs your firm to conduct business by practice area and department, how can you use this information?
By identifying these important metrics for your law firm, your firm can become more profitable, and your attorneys will be more fulfilled and effective with an improved clarity of focus.
There are a lot of fancy definitions for the term “strategic planning.” But at its core, all it means is to pinpoint a direction you want to go and then make decisions on how you plan on allocating your resources to get there. It is important to see the difference between strategic planning and marketing. And you may raise an eyebrow at that, but you’d be surprised how often people view these as the same thing. Strategic planning encompasses many operations of your business. Marketing is merely a piece of that coupled with things like your budgeting and reporting.
It is very important to note that strategic planning is not about grand ideas or mission statements. It is about where you want to be and how you’re going to get there, all within a short and defined timeframe that is typically no longer than 5 years at a time.
Typically, smaller firms can respond more quickly to changing conditions than larger firms, and because of this, there is a temptation for the smaller firms to get lackadaisical in their planning. Larger firms know that it is significantly harder to pivot, so they prepare and they do not take their strategic planning lightly.
From a high level, strategic planning consists of what we call a top-down planning process. Your firm has to first set the overall goal and then create a realistic framework and path that will allow you to get there.
For instance, if you set a goal for your firm to have a family law practice area in two years, the next question you have to immediately start asking is how are you going to achieve that? Your goals must always be measurable. Period. There have to be measurable objectives, otherwise reaching that end target is going to be very difficult and you’ll be more likely to set goals that are unrealistic in that proposed time period.
Once you’ve set your goal and defined your measurable objectives, the next thing you need to do is analyze your resources. What skills do you already have within your law practice and if you’re missing skills, what are you going to do to fill those gaps? Are you going to go out and learn them or are you going to hire people with those skills? When you begin analyzing your results, you need to also ask yourself, what do you need to get there? Sometimes firms will opt to hire an outside consultant to help guide them, others prefer to make those decisions on their own. Either way, you should figure out what assets you have and which assets you still need.
Schedules are busy, but it is essential that you and your team find time to pencil in status meetings into your calendar. Part of the reason you set measurable goals is so that you can measure them. These meetings don’t have to be once a week, they could be bi-weekly or once a month, but they do need to happen, and you do need to communicate with your team and constantly be monitoring your progress. Time always moves faster than you think, don’t let timelines and due dates sneak up on you.
Set a reasonable budget and adhere to it. You need to be asking yourself, what does your law firm's cash flow look like this year? How about your net income by year-end? Having a quality budget in place removes the guesswork and ensures you end up where you want to go. Additionally, ensure you have a good general ledger chart of accounts. If you are not familiar with the chart of accounts, it is simply a list of income and expense categories used to track your spending. Building a budget is a very crucial step in the process, if you’re wavering on how to begin, check out our 4 tips on building a better budget.
Planning is not everyone’s strong suit and that’s okay! However, having the ability to plan is crucial when you begin targeting and mapping out your firm’s future. Fortunately, being a planner is a learned skill for most people. But they say you don’t know what you don’t know, so if you’re unsure if you fall into this category, there are plenty of personality tests that you can take that will give you an idea of what your strengths and weaknesses are. The Myers-Briggs Type Indicator® is a great resource if you’re curious! Additionally, check out seminars from the American Management Association and the Chamber of Commerce.
Strategic planning sounds great, right? But what if you don’t have the financial background to adequately develop these plans? Don’t sweat it, you don’t need to have a degree in economics to know what you’re doing.
The key is to have a benchmark or expectation to see why your actual figures differ from expectations and take action based on what you find. The expectation in our financial management function is why we need a strategic plan and a sound budget. To start, use current and past budgets to create an expectation. Don’t make this part harder than it needs to be, take the information you already have and use it to build out the broader picture.
There are five basic financial statements you should be reviewing every month to help your strategic planning efforts:
This shows the financial position of a company at a specific point in time. This is usually run or prepared the first week after the close of each month. So if you’re going to look at your March financials, for example, you’re going to run them the first week of April.
This is why it is so critical that you have all of the financial transactions posted to your chart of accounts on a timely basis. If you’re at a larger firm and the accounting team starts putting pressure on you to get your timesheets in, this is why. If you haven’t posted all your costs, advances, your time, and complete your billing, then your reports will not be accurate.
Remember this formula: Assets = Liabilities + Equity
Your balance sheet is somewhat customizable when you’re comparing your designated points in time. You could choose to report on your current month, your activity year-to-date in a comparison against budget, or it could show you year-to-date in previous years. If you’re using a practice management system, you should have the ability to generate such reports. It is important to note that not every software gives you the ability to customize your reports whenever you want them. Many vendors will only offer boxed, off-the-shelf reports, so be wary of this, as typically firms end up needing more flexibility in their reporting than they initially expect or anticipate.
This reports on a company’s revenue and expenses over a period of time. Typically, the income statement is reported every month. Most law firms tend to lean towards cash basis accounting meaning that revenue is not earned until it has been received. Therefore, your income statement and balance sheet do not show accounts receivable or WIP. Those are separate, internal reports that you can run with your accounting software. Keep in mind that although these reports are run separately, they are crucial for your law practice.
We cannot express to you enough how essential it is to have a good chart of accounts so that your reports are meaningful. An issue that will make your accounting reports difficult to read is if there is not enough account detail in those chart of accounts. The chart of accounts should reflect the way your law firm is organized, for example (to name just a few) you could have reproduction expense, marketing expense, technology expense, partner compensation expense, etc. Doing this will make your reports more specific and meaningful to you.
Now, when you’re looking at gross profit and net income, or net profit, an important test to conduct is to look at your top paying clients and add up what these people or groups are earning for your firm. Then take that number and look at it as a percentage of the gross revenue. This is a good indication of how flexible your law practice would be if you suddenly lost that work. An even more telling test would be to do that same calculation, take your most lucrative type of work, and view that as a percentage of your net income. For a lot of law practices, this can be quite scary because it will show that they have very little to no flexibility at all.
This reconciles net income to the change in cash by showing sources and uses of the cash.
On cash flow statements, you’ll typically see net income first, followed by adjustments in reconciled net income, cash from operating activities, and depreciation. Other line items you might have include cash flows from investing activities and financing activities.
The owners’ equity statement outlines the changes in the owners’ equity accounts during the year.
In this statement, you will have members’ equity at the beginning of the year, then any contributions added by those members, added net income (money before distributions), and then finally the members’ equity at the end of the year following the dispersal of those distributions.
Now that we have taken a high-level look at these key statements, how do they all relate to each other? Are they even connected? Do they make a difference when you begin thinking about your strategic plan for the future of your firm? Let’s see...
So let’s look at the balance sheet, statement of owner's equity, the cash flow statement, and the income statement. If you look at your cash, this will be showing on your balance sheet and your cash flow statement. Your net income is also shown on your statement of owners’ equity, the cash flow statement, and it is also shown on the income statement. Owners’ equity is shown on the balance sheet, and of course on the statement of owners’ equity as well.
So you can see why naturally, all the statements have to balance and agree with each other. They are all interconnected and work to provide checks and balances to your firm.
All of these statements will ensure that your books are balanced and in order. Without this information, you will not be able to strategically plan for your future. Finance is all about the details and monitoring the cash coming in and the cash coming out of your firm. You don’t have to go at this alone, technology today has made it much easier to strategically plan and build out these reports the way you need them. If you’re unsure of where to start, take a breath, think about the direction your firm wants to go, and slowly begin mapping out how you will get there.
In, Accounting 101 for Law Firms we discussed how when firms are asked, “How do you want to define growth?” The leading response is always through revenue.
That is great, right?! “Revenue.” We all love this word, it’s great a great way to track performance, but how do you actually track revenue? Is it as easy as simply counting the dollars that come through your door? We wish.
The first thing you need to do is start utilizing KPIs. Your key performance indicators will be your best friends and the figures you need in order to answer the question, “how do I track my firm’s revenue?” It is important to note that these indicators are merely that, indicators. You should use them as a guide and lean on customized reports to really gain valuable insight into the productivity and performance of your firm.
At the end of the day, your firm is a business, so although you have spent 10,000+ hours honing your craft as an attorney or legal professional, you still have to be able to wear that business hat to keep the lights on.
That may sound dreadful, but don’t let the idea of numbers discourage you! These metrics can be used to help you make real-time business decisions that are going to greatly impact the future of your firm.
To jump right in, let’s talk about profit margins. That is how many cents on the dollar are you able to push into your pocket at the end of the day. If it is 35%, that means you get $0.35 of every dollar at the end of the day. Your profit margin can be looked at as your net income divided by your revenue.
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Next, think about how much your time is actually worth, or rather, your average rate billed per hour. This can be calculated over multiple time frames, but make sure the time frames you choose are always the same. So if you’re looking at the total hours billed for the month, don’t divide it by the total hours billed for the quarter. All of your time frames must match, otherwise, you’re comparing apples to oranges. You can calculate this amount by dividing the total hours billed for whatever time period you’re looking at, by the total dollars billed in that same period.
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The next KPI is important: your collection percentage. You work hard week in and week out, and although you may know how many hours you billed each week, do you know how many of those hours you’re actually getting paid on? It is easy to rattle off those initial billable numbers, but the numbers you have to dig for below the surface are much more valuable. So when you’re thinking about your collection percentage, take the total cash you have collected in a time period and divide it by the total dollar amount billed in that time period.
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Some more advanced ratios include things like how much do you spend per timekeeper at your firm? This is very important to look at. All you need to do here is take your total operating expense that you would get from your Profit and Loss statement and divide it by the number of timekeepers at your firm. This is going to give you a really great insight into how much it costs to actually run your business.
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Where it gets interesting is where you can use the figure you calculated from the operating expense per timekeeper to determine if you and your team are working on profitable clients. Profitability by client is huge because as you start to unpack this, you can quickly determine which of your clients truly brings your firm more revenue and which are just eating up your time. Everyone has a few clients where it costs you more to serve them, even though you may have higher billing rates. The problem with this is that most firms do not pinpoint these clients until the work is already done. So, to determine your profitability by client, simply take the fees generated by the client and subtract that estimated cost per timekeeper per hour worked.
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Lastly, are you hitting your targets? Your firm’s utilization is important because the more informed you can be about your productivity, the easier it will be to make decisions on matters like staff expansion. Is an extra timekeeper necessary for your growth or can you manage by simply shifting staff around? How do you determine what the right thing to do is? To calculate this utilization percentage, divide the total billable hours of a timekeeper by their total working hours. This percent may fluctuate throughout the year based on caseload, so it is important to keep your external factors in mind when making considerations for your staff.
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There are many KPIs and reports you can generate and use to monitor and track your firm’s revenue. You don’t have to be a finance buff or accounting expert to do this math, and once you start incorporating it into your weekly or monthly routine, it will become second nature! Until that time, we have tried to make it as easy as possible for you to get a handle on your numbers, so we have created a KPI calculator that you can access here to get you started!
In the unpredictable world we live in, it isn’t uncommon for you to wonder if your firm is charging too much or too little. Are your billable rates in line with your competitors? Is it best to bill by the hour? By flat fee, subscription? It's no question that there are a lot of options. So with all this in mind, how do you determine your firm's profitability? How can you make decisions that will be in the best interest of both your firm and your clients? Let's take a look.
There are five critical steps you should be taking when you're considering how to price or re-evaluate your legal services.
Yes, you are delivering legal services, but that is not your quote-on-quote product. Take the time to evaluate your niche and your unique value proposition.
Whether you’re a software company or a law firm, you are ultimately selling a product. There are millions of products in the world, so being able to narrow down and pin-point your offering is crucial to making you stand out. Are you a real-estate attorney with subject matter expertise in environmental liability issues? Are you a family law attorney who has expertise in same-sex couple adoption? As you begin to look at your profitability metrics, it is important to narrow down what your firm specializes in and use those case numbers to more accurately reflect how lucrative your firm is. Drilling down on what makes your firm unique will only bolster your client experience, but your profitability as well.
When you look at your revenue model and you’re considering how you want to bill your clients, the first place you need to be looking at and research are the market demands. Analyze what your potential clients want, what they are looking for, and what they’re demanding. Are you serving small business owners who may want to pay for services as work pops up? Or perhaps you’re serving primarily start-ups with small budgets who prefer to see all costs upfront? No two clients are the same, so it is important to understand what they’re looking for and how you can best meet those expectations. Additionally, you must also take into consideration the operational requirements needed to manage those clients. For example, if you’re billing hourly, then the operational requirements to successfully do this would require a software that allows you to capture and track your time.
The truth of any business is that it costs money to acquire new clients. Customer acquisition costs represent the time, money, and effort required to get leads and then convert those leads into paying customers.
Look at the data you have available. It is best to go over things in increments of 6, 9, and then 12 months to ensure you’re getting the most accurate information. When you’re considering your sales and marketing costs for your firm, the first thing you should think about is your time. This could be the time spent on business development, networking events, anything that takes time out of your day to pursue in the effort to expand your book of business. Next, tabulate any additional money spent on digital advertisement, or direct mailings. These hard costs will be the foundation for determining your customer acquisition cost. Your costs to close a lead are incurred through the bottom of the funnel activities that take up your time like consultations or meetings.
Let’s go through a fictitious example utilizing 12 months of made up data:
In this example, we took the estimated cost of your time plus the amount you spent on marketing and targeted campaigns to determine a total sales and marketing figure. We then took that figure and divided it by the total number of clients you work with throughout a given year. With that number, you subtract the final estimated costs associated to close that specific lead, and what is left is your total cost to acquire that particular client.
So going forward when you consider growing your business, this type of easy calculation will be able to help you understand that if you invest X amount of dollars, you will be able to attain X amount of new clients. By adding some predictability into your equation, you will be less surprised at the end of the road if things don't go your way.
Customer LTV represents the amount of business value or gross margin that is received over the course of a client’s lifetime. When that client first steps through your door, you must begin to evaluate how much revenue you are gaining from your client on a case-by-case basis.
Let’s go through a fictitious example of an attorney who bills by the hour utilizing 12 months of made-up data:
In this example, we took the number of hours this fictitious attorney was spending on Client X’s matter and multiplied it by their billable rate. Next, we took a look at how much money the attorney was spending to do that work. In this case, 25 hours of work resulted in 17 billable hours, which converts to a little over 70% profit margin. And lastly, we multiplied that total profit margin number by the total number of matters Client X typically brings to this attorney in a 12 month period. This resulted in an LTV around $14,400. A customer’s lifetime value is important to calculate because it will highlight to you which clients bring you repeat business without you having to spend those marketing and sales dollars to get them through the door.
Understanding how to calculate LTV in this easier scenario will allow you to replicate this information when you start looking at multiple fee arrangements. Like discussed earlier, if the market is demanding subscription billing, or consolidated billing (to just name two), you and your firm need to be able to meet these needs in order to remain competitive. Your customer experience will make or break your business, and how your clients want to be billed needs to be met with “yes we can make that happen,” not “sorry, we cannot accommodate that billing arrangement.”
At this point, you have figured out what expertise and skill set you have that sets you apart, you have determined what specific product you’re offering, how your want to set up your billing structure, how much money it costs for you to get clients in the door, and how much margin you can generate from that client in a given period of time. The last step now is to understand your fixed costs. Fixed costs represent the amount of money you are spending to support your law firm as a whole. On an annual basis, how much money are you spending to pay the firms office rent, support staff, legal technology, annual license fees, etc? These are your fixed costs.
The things that are really important when you look at customer acquisition costs and lifetime value are the scalability of your law firm and whether or not you can be sustainable in the long term.
The first thing you can do when you have these numbers is to look at how long it takes you to recoup your customer acquisition cost. To do this, you take your total $627 CAC cost and divide it by how much profit you generate, which in our fictitious example was $4,800. So, what this means is that you recoup your CAC by the time you are 13% of the way through your first case with that client. A general rule of thumb is that you recoup your customer acquisition costs within that first year of starting the particular matter. This low percentage indicates that you have a little more room to spend on acquiring new clients if you so choose.
The second thing you must do is ensure you’re making money over a customer’s lifetime. If you take the $14,400 LTV we calculated in the fictitious example (profit per case multiplied by the number of cases that client brings to you in a year) and divide that amount by the $627 CAC cost, that’s roughly a 22.3x return on investment per client. This is a huge number! This indicates that you could lower your billable rate to get clients through the door and still make a decent size profit. Do your research and determine where the market stands and then evaluate if you have room to adjust.
Your CAC and LTV are what we describe as unit economics. In the long term, if what we calculated are your unit economics, can your firm ultimately make money? The answer would be yes. From a business perspective, there are always things you can do in the short-term that will get you by, but those bandaids will eventually come off to reveal a less than favorable result. Let’s do some quick calculations. If you’re generating $6,800 in revenue per case (determined from our LTV example), and you’re taking on about 50 cases per year, that’s about S340,000 in annual revenue. Now let’s say your direct costs total around $95,000 a year to serve that revenue, you’re left with a gross margin of around $245,000. Now, after your fixed costs, and sales and marketing expenses (for this hypothetical example, let’s say those total up to $50,000), your total income before tax comes to $195,000. If you can make these calculations each year, you will be able to determine if you can serve your clients profitably, while also saving enough cash for future growth.
All of this leads to what you should walk away with… without favorable unit economics, you will not have a sustainable law firm in the long run. Understanding how much it takes to bring new clients in and how much money those clients bring to your firm over the course of their lifetime will ultimately tell you how successful your firm will be in the future. There are levers you can pull after you understand this data. These levers are either revenue or pricing driven like billable hour vs. flat fee, or whether you’re above market or below market. You can adjust these metrics accordingly. The other thing you can do is adjust your service levels. If you’re spending too much time serving one client then you need to either keep your service level the same and bump up your rate, or if your rate is already in line with your competition, then keep your rate the same and spend less time performing that work.
The goal is to understand your data at the customer level to determine whether or not you’ll be successful in the long term with your entire book of business.
