To See Better Profits, Look Harder at Where Money Starts & Ends

THE NEWSLETTER FOR LEGAL OFFICE MANAGERS
LAW OFFICE ADMINISTRATOR
Volume XXI / Number 11 November 2012
(Reprinted with permission of Ardmore Publishing Company)

Profit doesn’t happen without a prod.

Particularly in a tight financial environment, a firm has to know where its money is coming in and going out. It also “has to be nimble and on top of what’s going on,” because the supply, the demand, and the acceptable price of legal work are constantly changing, says BOB HENDERSON of RJH Consulting, a Jackson Hole, WY, the business consulting group for small to mid-size law firms.

The job of today’s administrator is to know where the profits should be, where they are now and when and how to change.

IDEAL = 50%; REALISTIC = 40%
What’s the ideal profit level? Any full-service firm should be seeing a profit percentage of 40%, Henderson says. Or in dollars, if revenues are $1 million, overhead should be no greater than $600,000 and profit no less than $400,000.

The ideal is 50%. But few firms can maintain that because the cost of doing business is always going up and it’s rarely possible to increase the rates by the same amount. But don’t look at any ratio as dogma, he says. It varies by firm.

Firms that do plaintiff’s work, for example, usually have a high overhead because of the number of employees needed to handle the cases. Partner distribution also varies. And so do partner perks. Some firm covers the partners’ car expenses, for example, while others don’t. Overall, however, any firm that is below 40% “needs to take a look at what’s going on.”

Higher Rates For Higher Law Firm Profit
To improve the profits, start with rate increases wherever they can be made. There’s no rule on when or how much to raise rates, but in general, they need to keep pace with the cost of living. If that goes up 2%, the rates need to go up the same or the firm loses money. Other factors also come into play.

One is what the competition is charging.

Another is what the practice type will bear. Real estate, for example, has not supported a rate increase for quite a while and won’t until the market picks up.

Another measuring tool is whether the firm is achieving the profit margin it wants to see. If the business has increased substantially, the law firm profit margin should be up. If not, the firm is probably charging too little.

Along with that, evaluate the demand for services in each area. Where the business has increased, demand is obviously somewhat high and a rate hike might be in order. Not so if the business is scant.

Never Lose Sight Of The Numbers
Constant review of the numbers is also essential. Henderson recommends meeting monthly to review the profit and loss statement as it compares to the budget and discuss ways to improve it. Doing that, the firm can make ongoing adjustments to the work and productivity and billing and outlays so the money picture stays on course. Otherwise, the partners might go ahead with a plan to hire new staff in April, unaware that a huge unexpected expense in February has made it impossible for the year’s revenues to support that expense.

The ongoing reviews show too if individual expenses are getting out of hand. And they identify problems early so the firm doesn’t find out six months into the year that one attorney has billed only 500 hours.

Unfortunately, he says, a large number of smaller firms don’t operate with a budget and never look at the profits and losses until year’s end.

Who’s Billing What And How Much?
From there, turn the attention to increasing the profitability of the individual attorneys. In most cases, a partner should be billing 1,500 to 1,600 hours annually while an associate should be at 1,750 to 1,800 hours. Anybody doing less than that is obviously not productive, and it’s time to pinpoint what’s holding up the money. It could be the partners aren’t passing down enough work to the associates. Or maybe the associates need guidance on business development.

Look further at the individual collection percentages. They should be no lower than 90%. If they’re not meeting that level, it’s possible the firm isn’t screening out prospects that can’t pay the bill. Or the bills could be going unpaid because of client dissatisfaction.

Also look at how much time each attorney has written off and written down. There’s not much excuse at all for write-downs, Henderson says. “An experienced attorney should have a very low percentage there,” because time that doesn’t justify billing is wasted time that should have been spent on revenue-generating work. As for write-offs, those should be at less than 10%. Any attorney who has more is either not satisfying the clients or not billing out on time.

Paying For The Paralegals
Paralegal and legal assistant billings also need attention. There’s often room for considerable increases there, Henderson says because most firms do a poor job of tracking non-attorney time and billing it out. There need to be billing expectations for the paralegals just as there are for the attorneys, and on average that should be 1,200 hours a year. At that level, the firm recovers the cost of those employees.

He points out that contrary to what many attorneys think, clients don’t resent getting charged for the non-attorney time. “They actually prefer having their work done at the lowest and least costly level.”

To avoid the concern entirely, get approval up front. Include in the client agreement a list of the billers who will be working on the matter and their rates.

Good-Bye, Sagging Practice Area
Another money builder: get rid of the unprofitable practice areas.

Some areas are cyclical, and where that’s the case, the firm needs to be flexible and willing to change focus. With the drop in the real estate market several years ago, for example, firms that moved from real estate to bankruptcy did well.

Some areas are consistently low revenue generators. An example is Worker’s Compensation defense, which is not only low paying but also requires a lot of attorney hours. The firm may want to drop that type of practice.

The decision depends on the financial picture. If an area is low profit and overhead is high, it probably needs to be replaced. But where overhead is low, the firm may benefit by continuing the work because it’s steady, albeit small revenue.

There’s also the consideration of whether a not-so-profitable area is bringing in referrals to other more profitable areas. Firms that want to do estate administration, for example, usually need to do wills as well in order to get the business.

“There is a lot of judgment involved in determining what is an acceptable loss leader,” Henderson says, and there’s no rule to follow. “Somebody has to have a good sense of the numbers to say ‘okay, we don’t make money here, but it’s bringing in a lot of work.”

Don’t Carry A Losing Partner
Finally, look at partner compensation.

“It’s quite common to see attorneys who are low producers year in and year out,” he says. Large firms don’t accept that, but smaller firms often do because they don’t want to confront a partner.

If a firm wants to improve profitability, it has to get rid of its non-productive members or, if it’s not willing to do that, to reduce their compensation to a level that reflects their contribution.

That may require revising the partnership agreement to give the group the right to adjust compensation. Then the firm can tell the non-productive partner “it’s not fair to the others that you get this much income, so we are reducing your compensation according to the work you do.” That’s neither easy to do nor easy to hear, “but it’s a fair alternative to just letting a partner go.”

RJH Consulting provides strategies and solutions to help increase law firm profit. Contact us today!