The Single Most Important Piece of Financial Information In All Law Firms… The Real Key To Profitability…

Seldom a day goes by in which I do not encounter someone involved in law firm ownership/management getting very focussed on the wrong performance indicators for their firm, including data that does not really indicate good performance at all.

Many Principals tend to be very short-term focussed on, for example, fees rendered for the month, and the current month Profit and Loss.

Even supposedly professional managers regularly overlook the most obvious and fundamental issues, and devote far too much energy in areas that are not the powerhouse of profitability, and therefore ongoing financial stability and strength.

The source of all Revenue is the effective effort that the firm’s human resources invest working at the firm’s Business Plan.

In any given period pretty much all of the firm’s Expenses are invested into making those resources available, to work mainly on clients’ files, ClientTime?…and to a lesser degree on the firm’s own “matters”, FirmTime?.

The ongoing Revenue potential, and therefore profit potential, can be quite reliably calculated, using indicators that can be continually reality-tested as the months unfold.

Investment of ClientTime? will, in shorter or longer timeframes depending upon the work type and firm’s credit polices etc., ensure clients can be billed according to the terms of each retainer.

Investment of FirmTime? in planned areas like marketing, knowledge management, training, processes, supervision etc., will ensure the firm has future work in the right volumes and can process it efficiently and deliver value to clients for the fees sought to be rendered and collected.

The real key to profitability is in properly planning the FirmTime?/ClientTime? mix for each team member, and then ensuring that it is consistently achieved or exceeded.

Fees rendered, or collected, at any given time are unfortunately not at all a good indicator of whether the firm’s resources are being consistently correctly deployed according to team member WorkPlans?, ensuring that both short term and long term Business Plan objectives are likely to be achieved.

Leave aside additional business environment disruption factors of more recent times throwing in extra curve balls.

Real profits in small-medium law firms have as long as I have been observing for the last 45-plus years not been all that good after properly taking into account a salary for the work of Principals.

These days real profit margins are quite small, and with added pressures of slower than reasonable fee collection, and sometimes poor file velocity, cash flow pressures can be very challenging indeed.

If resources are under-utilised by even ten or fifteen per cent the real profit margin of a firm can be completely eliminated, with Principals convincing themselves that their paltry returns (less than a proper salary for their efforts) are in fact acceptable returns for their efforts and their capital invested. Of course they are not.

Take a typical example of a small firm with current Revenue of $1M.

With one Principal’s salary allowed at $200,000, and other Expenses of $700,000, the real profit is just 10% of Revenue or $100,000.

If the key resources can use their days just a little closer to what a sensible WorkPlan? indicates they should be able to do, annual Revenue of $1.1M is quite easy to achieve…a 10% increase only.

However, real profit jumps to $200,000, an increase of 100%.

I see examples of this simple scenario all the time, and considerably worse, and even firms that are doing much better already always have the opportunity to use resources closer to WorkPlan? potential.

So how to go about it?

The answer is real people management...to get all resources working reasonably effectively on sensibly-crafted WorkPlans?.

Usually that is just a case of properly explaining what is required to every team member affected, and then regularly monitoring and providing feedback and ongoing encouragement.

The key performance indicator each month then becomes the degree of gap between the value of Raw Work In Progress that should be created by the team of people working the number of days they collectively worked, and the actual Raw value created.

Planning and tracking this accurately is very important, as months vary significantly in length (17-23 business days), and all types of leave impact on available effort in any given month, so less production on those days with less of the team on deck doesn't reflect a poor return on your investment. We are looking carefully at what your valued team members do when they are actually working for you, from wherever that may be.

I use “Raw WIP” here simply to signify that it has not been realised yet, and we do not yet have an actual Realisation Rate resulting from the Raw WIP/Actual Billings comparison.

The two graphs below indicate how the performance/profitability transformation usually takes place as the key resources begin to be better utilised and applied to the key challenges. These graphs are actual data from a client firm...not mock-ups!

The top graph shows the monthly new Raw WIP produced gradually moving from consistent shortfalls (red column caps) to varying surpluses (green column caps).

It can be seen clearly that in a much shorter month such as April, where usually significantly less is created, there can still be a surplus over the WorkPlan? potential of the days the team members actually worked.

The next graph shows the annual projected Raw WIP shortfall (or now surplus) plotted each month, with the massive projected annual shortfall early in the project gradually reducing, and heading inexorably towards a breakthrough to an annual surplus.

In the Sole Principal practice from which the figures derive it is easy to imagine the very significant impact on profit margin!

Significantly, the WIP shortfalls occurring in the practice were not resulting from a shortage of available work.

If early analysis had revealed that existing marketing activity was insufficient to produce enough new files to fully support the firm’s production resources, urgent action would have been required to increase momentum with a focussed, beefed-up, marketing plan.

It should be noted that where the average file value in a firm is for example, $10,000, it requires less than one extra file a month to boost the capacity to produce Raw WIP closer to what WorkPlans? demonstrate is possible, by $100,000 annually.

I have never encountered a small-medium firm where new files cannot be lifted significantly with some relatively straight-forward additional marketing effort.

If a practice is keen to expand, knowing how to use key resources properly, and how to market effectively to ensure enough work is consistently available, will ensure the growth is fully worthwhile.

The Bottom Line…

To impact profit positively managers need to fully understand this one really important piece of information, the productive capacity of their engine room, identify where there is a gap between potential and actual, then do the right things to eliminate the gap. 

From a profitability perspective it doesn't make a lot of sense to be spending on resources that are not producing work in the profit zone. Identify and own the problem, and own and implement the simple solutions.