Robservations relevant to the financial health of the legal profession’s smaller firms...

With end of another calendar year approaching at warp speed here are a few Robservations for those of you interested to mull over before re-launching, refreshed, into practice in 2024.

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Profitability underpins financial health, reasonable liquidity, and maintenance of acceptable levels of owner stress.

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That’s very easy to say, but there are many factors at play in achieving appropriate profitability, and the fundamentals are not always well understood...hence why so few small legal practices are consistently appropriately profitable.

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At the most basic level, the revenues of the practice must be sufficiently higher than the firm’s expenses, including a commercial salary for owner principals, that a reasonable return on investment is generated.

For sake of absolute clarity, the commercial salary of a working owner is an expense, not part of practice profit.

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In terms of cash flow, not just profit, it is obviously very helpful if the revenues are collected without undue delay.

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As expenses keep rising, revenues need to at least keep pace to avoid profitability falling and liquidity tightening.

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Here’s the first profitability conundrum for so many practices.

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Firms far too often have blinkers on when it comes to increasing revenues, and don’t look beyond charge rates as the main (blunt) instrument for increasing revenues.

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Unfortunately, I see some firms holding off raising rates because they are concerned about attracting less work, some raising rates without doing enough to ensure enough value is added, and most not doing enough additional business development to create stronger demand in parallel with other initiatives.

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Utilisation of fixed-fee services offerings, coupled with additional effective business development, can attract sufficient enquiry to allow conversion into new files at volumes that will close revenue generation gaps at individual lawyer (or team) level.

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Getting better revenues from current people resources without raising rates can have very immediate and substantial impacts on profitability.

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Available resources may be too great (and therefore expensive), for the convertible enquiries you can generate, even with some additional business development.

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Look at where existing resources can be re-deployed without redundancies, and when natural attrition occurs do not pavlovically hire replacements. Take every opportunity to thoughtfully consolidate, and reduce expenses that are not working well enough in generating revenues.

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Moving a willing, but under-utilised, employee into an area of work where your data shows you can more easily generate additional work at a good ROI, can reduce expenses in one area short of work, and increase revenues faster in another.

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Strategic awareness...

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Hours actually worked annually are increasing for many owners, and decreasing for many employees. All-round wellbeing is important for all, and good levels of holidays are one important part of that complex challenge, but more holidays does not automatically ensure improved productivity or acceptable (and most essential) profitability.

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The conundrum here is that owners need to have more time for smart management, and that will not be freed up by them personally doing longer hours on client files for lower fees than their experience and skillsets justify.

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Even the most willing employees cannot typically gain enough new work to keep themselves fully busy, and without a practice system that is well designed and operated to bring enough enquiry in, a traditional model of owners over-worked and employees under-utilised will persist.

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That model typically generates insufficient revenues.

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Credit control...

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A persistent trap lies waiting in firms that take on work to keep busy that will not generate cash in reasonable timeframes. Liquidity will deteriorate unless cash borrowed from owners or external lenders can be injected at acceptable cost to underpin the expenses until closures, and cash availability, catch up.

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Many practices are heavy borrowers already, so IMHO it is better to fix the broken wheels to ensure sufficient profitability for all needs, including reducing borrowings to safe levels from after-tax returns.

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Close supervision is important here. A busy employee can create a cash problem for you not just by having one or two delinquent large debtors, but just as easily by having many who on average pay late.

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Funds in Trust, regularly topped up, can be maintained well by a firm that generates enough enquiry to be able to insist on its credit terms.

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So much hinges on that flow of appropriate enquiry, and it does not generate itself, it takes consistent, focussed, effort.

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The bottom line...

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Time and time again the origins of poor financial performance are found in the owner cohort not knowing what the most effective business development levers are, and therefore what practical steps need to be taken to produce much better enquiry levels for suitable new work and additional revenues to flow as soon as possible.

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As with so many things in life, the sooner we start doing the right things the sooner we will see improved outcomes.

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As 2024 unfolds, lot of distracting, apparently important or interesting, or worrying, “side-shows” will appear on your radar. This has been the case for a very, very, long time.

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Running a successful, financially healthy, rewarding practice certainly requires an ability to be aware of what’s new that may be critical, but that awareness cannot be allowed to overpower focus on far more critical fundamentals.

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All the very best...here’s to a wonderful festive season and holiday break, and a very healthy, rewarding, and satisfying 2024.

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Rob Knowsley

Managing Director-Principal

Knowsley Management Services? (KMS)

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