A law firm is first and foremost a business; and in order to succeed and grow, partners must view, operate and manage it like a business. Gathering and analyzing law firm business data is often overlooked, but by measuring the right metrics, inefficiencies can be identified and improved, leading to increased profitability for the law firm.
Key Profitability Metrics (KPMs) can provide detailed insight into those areas that impact the firm’s profitability. Understanding profitability metrics broken down by client, matter and timekeeper is just the tip of the iceberg when it comes to understanding the profitability equation in regard to the legal profession. When you know the numbers behind revenue and dig deeper into direct and indirect cost allocation, you can improve the delivery of legal services with a focus on efficiency as well as quality and speed of service.
Here are some of the top KPMs law firms should capture and understand in order to improve their bottom line and net margin:
Revenue - No matter if client billing and collection is based on contingency, flat fee or by the hour, one thing remains consistent: in order to understand profitability, you must know your timekeepers’ productivity numbers. When you multiply billable hours for the practice, office, or timekeeper by the applicable billable hour rate you are calculating revenue. Revenue, based by timekeeper, can be a direct indicator of productivity. Improving productivity increases revenue which means more profit for the firm.
To learn about factors that affect law firm's revenue and profits, read our blog post, 7 Law Firm Profit Killers.
Direct and Indirect Cost Allocation - An important factor in the profitability calculation is knowing how and which firm expenses should be allocated to fee earners. Some of these costs are connected to particular attorneys, groups or the firm. Typically, they are broken into direct and indirect cost, as follows:
- Direct costs are expenses connected directly to an attorney such as compensation, bonus, payroll taxes and time and expense (T&E).
- Indirect costs are not chargeable to a particular attorney and include line items such as rent, marketing, and legal administration costs and compensation. Indirect costs are typically divided into two separate categories: practice group indirect and firm indirect. Practice group indirect costs are those costs directly related to a particular practice group, such as legal administration compensation or marketing costs. Firm indirect costs, on the other hand, cannot be directly connected to a practice group. This includes items such as rent and administration costs related to the entire firm.
Some things to consider when setting up calculations for indirect costs, include:
- Should marketing costs or secretarial costs be divided equally among attorneys?
- What if some attorneys don’t use particular firm assets, such as paralegal or marketing services?
- How will additional compensation, such as employee benefits, be handled?
- What if multiple attorneys are working on a single case?
- Does one practice area use more firm services than other practice areas?
- Which practice areas are more profitable than other practice areas?
- Will shared expenses be weighted? A common practice is to allocate a higher amount of some categories to partner, a smaller amount to associates and counsel, and the smallest amount to paralegals.
Equity Bonus - Different firms have different opinions on whether or not partner compensation in the form of equity bonuses should be included in the calculation to determine revenue. One thing to consider is whether or not equity bonuses are included when stating yearly salaries. If so, attorneys count on that equity bonus as a guarantee. Breaking that promise, most likely will result in those partners leaving the firm. Increasing the likelihood of collecting the revenue necessary to keep those promises through accurate profitability tools and reporting dashboards is good for the firm’s reputation and retaining valuable employees.
How are equity bonuses calculated? In many law firms, they are based on the following criteria:
- Billable hours
- Revenue realization
- Bringing in new business
- Generating more business from existing clients
- Improving the firm’s image
- Leadership and mentoring
- Charitable and pro bono activities
- Professional development and accomplishments
- Draw distribution
Why Use KPM Platforms Designed Specifically for Law Firms?
Selecting a platform designed to meet the modern law practice’s complex requirements makes sound business sense for partners. Designed to handle KPMs in ways general software simply cannot, the right KPM platform gives law firms the tools to become more profitable by supplying critical information in the following ways:
- Client/matter profitability - Having a grasp on your law firm is a lot more than knowing details about each case and new leads. Firms that actively measure profitability by client and case are positioned to grow and prosper with a better understanding of their financials and return on investment than other firms. Firms that scrutinize their metrics are in a better position to prosper and stay in control of their practice.
- Profitability across timekeepers - When the cost rate is entered for each profile and a legal matter is opened and time recorded, fields throughout the system (such as timekeeper, class, timekeeper status, task, matter, matter type, client, client industry, practice area, department and office) are automatically updated. Having access to current profitability metrics in real time is a huge benefit for law firms. Being able to gather time and profitability data for individual attorneys aids in correctly pricing non-hourly projects.
- Identify staffing needs within practice areas - A sophisticated dashboard can be a powerful tool and take away the guesswork about how practice areas are managed and staffed. By having this knowledge at your fingertips, you can manage caseloads and marketing programs better. No longer will you guess which practice areas carry the less-profitable ones. Likewise, you will know for certain which practice areas drain the firm’s bottom line. Using well-managed practice areas as role models, other areas can be re-trained to be just as successful.
BigSquare’s enhanced Profitability application gives you the tools to turn time into money. With only access to an internet browser, slicing and dicing a library of profitability-related metrics against key firm dimensions has never been easier. Some of the most valuable metrics include (but are not limited to): clients, matters, practice groups, departments, offices, timekeepers, matter arrangements, titles, and much more.
Information is targeted and secure so you can provide profitability metrics to the right individuals at the right time without the need for expensive third-party report writers or costly vendor supplied reports. When you run your law practice like a real business, efficiencies and increased profitability are sure to follow.
Download our free Viewpoint Document, The Keys to Successful BI for Law Firms, to learn how Business Intelligence can give you increased insight into your Key Profitibilty Metrics.
BigSquare is the leading provider of Business Intelligence for law firms and professional service organizations. We focus exclusively on law firm reporting, law firm BI, law firm profitability and law firm analytics.