The difference between a profession and a business is paramount. While higher education and passing the bar exam are prerequisites for becoming an attorney, there are no prerequisites for learning how to run a law practice. Yet, there should be. Despite the high achievement of attaining a law degree, attorneys often skim over the fundamentals of running a business and fall prey to these 7 finance and profitability mistakes.
1. Don’t make data-driven decisions
In today’s client-driven environment, in order for law firms to succeed they must improve profitability without raising billing rates. The combination of fierce competition in the legal profession and high client demand has given way to data-driven decision-making through comparative profitability metrics that can sophisticatedly analyze practices, clients and books of business.
2. Rely on single metrics
Single metrics can no longer provide the answers attorneys need to improve their firm’s bottom line. Instead, attorneys must pull from a number of performance indicators such as accounts receivable, work-in-progress, timekeeper, and realization reports to ascertain where the firm could be working smarter. Intelligence gained through analytics and comparisons such as hours worked versus hours billed or hours worked versus fees collected are key to running more profitable firms.
3. Continue to use “billable hours” as the only pricing model
Although the traditional profitability metric for law firms has been tied to “billable hours”, today clients demand law firms to deliver better value and alternative fee arrangements. With the decline of “billable hour” pricing, new pricing models such as fixed fees, caps, threshold discounting, and other payment methods require firms to precisely measure partner performance (through productivity and profitability metrics) in order to provide accurate budgeting estimates.
4. Don’t take advantage of improved metrics
To better manage firm finances, enhanced metrics provide insight into the firm’s profitability and efficiency in the following ways:
- Profitability metrics such as profits per partner, leverage, extended leverage, realization, return on capital, value of income stream, etc. provides the necessary knowledge to adjust performance and reduce risk.
- Expense metrics (expense per lawyer, staffing ratios and compensation) allows the firm to staff more efficiently and put money back in the firm’s pocket. Good expense metrics will include often forgotten labor costs, such as the cost associated with the time and effort required to find answers to legal questions using the available solution(s). Both direct costs pertaining to the time required to research and indirect costs pertaining to the time required to conduct analysis and apply doctrines, such as in client advice or motion practice must be accounted for in order to get the true picture. Finally, quality costs refer to the indirect consequences of incomplete or inaccurate research.
- Partner performance metrics such as work generated, cost to manage a case, fees and growth, profit generated, realization, leverage, client satisfaction rating, recommendations, and cross-selling provide invaluable information about timekeepers such as who is creating profit for the firm and who isn’t. Metrics like these report the effectiveness of asset and debt management, assist in identifying the need for more discipline or greater innovation in pursing firm goals, and are useful in monitoring and measuring a firm’s financial leverage, liquidity, and overall health.
- Client metrics such as client diversification, fee growth, case origination, etc. gives information about the brand strength of the firm. Drilling down further, management and leadership metrics per partner provides the firm their return on human capital.
- Firm metrics provide information about the degree of competition a firm faces, the strength of demand within the marketplace and the state of the economy.
5. Don’t prepare for the changing environment
Firms that have not yet adopted profitability analysis will need to do so in order to position themselves in the changing legal environment or otherwise be left behind. Highly profitable firms are the ones that understand how core metrics interrelate to produce net profit numbers. This knowledge will drive new ways of doing business and result in more advanced performance management systems.
6. Don’t work to reduce cost
The increased pressure to reduce costs resulting in part by the current flat pricing demand trend for legal services, has created an environment in which improvements to a firm’s cost structure and cost accountability are vital to its survival. Understanding the interrelation among different profit areas in relation to the overall firm net contribution is one of the key components to impact profitability. By identifying poorly functioning areas, you can offset that loss by cultivating those areas with a stronger return.
7. Don’t look for areas of growth
Those practice areas with the highest billings and collections identify possible growth within an industry. Consider how you can target that for new client development. A true matter-based profitability application should be part of a firm’s wheelhouse for better positioning itself to drive value to clients and a bottom-line profit to the firm.
Utilizing these improved metrics to measure the health and effectiveness of the law firm can greatly impact performance, increase profitability and deliver the kind and quality of legal services that clients now demand.
Industry-wide, law firms must search for ways to become more efficient. Whether this is in reaction to new pricing demands or ongoing competitive challenges, these pressures continue. As a result, the need for more sophisticated firm management tools within the legal profession has intensified. Attorneys and law firm partners must manage their finances and profitability with newer, more advanced approaches.
Industry-wide competition has forced partners to reconsideration how to deliver value to clients without sacrificing the goals and strategic vision for the firm through innovated means. By using metrics to help turn data into knowledge, firm management can be facilitated and improved by reviewing performance and profitability metrics to predict future revenue and growth, efficiency, risk and return on capital.
If you are looking for ways to eliminate financial mistakes and increase your law firm's profitibility download our free Viewpoint Document, The Keys to Successfull BI for Law Firms!
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