How to Know Something is Wrong with Your Law Firm Economics

Posted by Sarah Rosenberg on Thu, Oct 05, 2017

How to Know Something is Wrong with Your Law Firm Economics

by Sarah Rosenberg / October 5, 2017

How To Know Something Is Wrong With Your Law Firm EconomicsToday, the landscape of the legal profession has shifted drastically. In order to compete law firms must be a collaboration of legal competence and economic business savvy. Each are equally important. Many law firm partners fail to recognize the early warning signs that something is wrong with their firm’s economics. Instead, they ignore them hoping they will self-correct given more time or they don’t really understand the impact economics has on the firm.

This blog will highlight the warning signs that your law firm’s economics are in trouble so that you can act sooner (rather than later) before it’s too late. To ensure firms can meet these challenges a watchful eye on the firm’s economics is paramount to its success. Here’s what to look for:

Unstable Cash Flow

Without understanding the importance of money moving in and out of the law firm, partners dip into their line of credit to cover necessary expenses. This can jeopardize the firm’s survival. The gap between paying expenses and getting paid by clients is considerable—often as much as 105 days. This means that you most likely have paid for client-related expenses before you have even invoiced the client. If your time recording, billing and collection processes are not monitored frequently and timed effectively, waiting for fees can put a big strain on your cash flow.

The flow of cash is further restricted when law firms grow their business too quickly. Expansion requires more space, new equipment, additional employees, paid benefits, etc. Adding a new attorney to the payroll often means that the firm pays for months of salary before the attorney even begins billing clients. Multiply that cost by the number of new associates and you can see how it can deplete your cash flow.

The outlay of client expenses for in-progress cases can also weaken the flow of cash. The firm’s financial team should be conducting cost analysis by reviewing expense data to identify ways to cut these costs. Simple things like providing in-house services rather than outsourcing or having the client pay the expense directly can ease the strain.

Other ways to improve cash flow is to make sure the firm’s policies for accounts receivables and accounts payable are as efficient as possible through a cost/benefit analysis of the firm’s economics. This will aid in decision-making when it comes to taking discounts or stretching payments. Even simple thing like paying invoices by due dates and on time allows you to take advantage of early-payment discounts and avoid late fee charges. Use payment deferrals, and negotiate for lower prices and discounts. Even little changes when added up can have a big impact on your cash flow.

Too Much Contingency Work

Firms that take work on contingency, such as personal injury lawyers, often have accounts payable tied up for years before getting paid. Too much contingent work can wreak havoc with your economics unless you master the churn cycle of these cases efficiently.

Whenever possible, have clients pay fees for court reporters, expert witnesses, transcripts, exhibits and travel expenses directly. To better control client advances you should set some guidelines and/or boundaries.

As insurance companies refuse to settle cases or stretch out the timelines for settlement, many 100% based contingency fee practices are incorporating non-contingency practice areas to their work load in order to improve cash flow.  Smaller firms may consider joining forces with another attorney with a complimentary non-contingency book of business to create a better mix of contingent and billable hours.

Inefficient Billing

Good cash flow requires prompt billing. Collecting a bill in full is greatly increased by prompt billing, yet the amount of late billing or unbilled time continues to be a problem for many law firms. According to the American Bar Association, bill at appropriate times, even if it is not the regular billing date. They say that you should bill immediately upon completion of a matter, whether you were successful or not, and at appropriate intermediate times. For example, send a bill:

  • When the deal is signed, even if the closing is coming later

  • When you have just won an important pre-trial motion or discovered something valuable at depositions

  • When an item of due diligence has just turned out to be favorable

Keep on top of finances to identify late or delinquent clients so that you can stop work until payment. Don’t fall into the habit of using quarterly and year-end bank reporting as the time to follow up on delinquent payments. Instead, review receivables frequently so you can follow up quickly.

Some firms distribute monthly reports highlighting unbilled time and accounts receivable over ninety days old for each partner and/or attorney. Other firms review unbilled time and delinquent billing with the culpable attorney when the amount reaches a certain threshold. Either way, a little peer pressure when it comes to cash collection, prompt billing and follow-up on accounts is good news for the firm’s economics.

Timekeepers Don’t Keep Their Time

Accurate and prompt time recording by timekeepers makes it possible to learn much about your legal services, including costs incurred and duration of certain tasks and cases. This information will assist in timing future tasks and pricing non-hourly projects. Every timekeeping transaction should include: a detailed description of the work, the date the work was started, the attorney or staff person assigned to the work, the date the work was completed and the project or case number where the work should be billed.

Non-billable time spent on marketing, business development, recruiting and firm administration should also be recorded to fully understand the economic health of the firm.

Too Much Discounting

Attorneys like to make clients happy and one way to do that is to agree to discounted prices when clients ask, but that is not always a sound economic decision for the financial health of the firm.  Having a good handle on the economics of the firm, means that you have the expertise to consider and discuss discounts to ensure a healthy profit.

Not Preparing for Alternative Fee Arrangements

Over the past several years, due to high client demands, flat rate fees have been on the rise. In 2009, 28 percent of law firm leaders believed that non-hourly billing would be a permanent change in the legal industry, according to legal consulting firm Altman Weil. By 2013, the figure had jumped to 80 percent. As the demand for this pricing structure continues to grow, law firms must figure out how to charge non-hourly fees for litigation instead of billing by the hour.

The best way to accomplish this is by reviewing and analyzing historical data in your firm. How much did similar litigation cost? How many hours were spent preparing for comparable cases? How much did it cost to file a complaint? How much did each deposition cost? Can the cost be reduced by using prior work and/or prior resources?  Ideally, separating litigation into phases and reviewing prior data for that phase, allows for successful pricing.

A firm of high-quality, experienced and competent attorneys is no longer enough to create success. Demands of clients and competition among law firms have created big changes in the way legal services are priced. As law firms move away from straight hourly billing to task-based billing, contingent fees and fixed-fees, it’s more important than ever for partners to understand their firm’s economics.

Compared to the methods lawyers and law firms used in the past, today they must become more efficient to remain competitive. When technology is used to provide insight into the firm’s economics, competitive pricing can be achieved, resulting in happier clients and more business.

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Tags: Law Firm Economics

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