How To Improve Firm Profitability

Let's begin with a short quiz. Two firms each have $20 million in revenues. One firm has 40 equity partners. Its cash-basis profit & loss statement shows a profit of $8 million, 40%. The other firm has 15 equity partners. Its cash-basis P&L shows a profit of $6 million, 30%. Which firm is the most profitable?

Answer: The second firm.

There is no trick here. Many lawyers measure their firm's profitability the way a company does ' as a percentage of sales. However, the correct way to measure the profitability of a law firm, whether it is a partnership or a professional corporation, is the net income per equity partner (NI/EP) (or shareholder). The first firm above has a NI/EP of $200,000 ' $8 million divided by 40 partners. The second firm has a NI/EP of $400,000 ' $6 million divided by 15 partners. Therefore, when analyzed correctly, the second firm is far more profitable and makes far better use of its resources.

It is axiomatic that the best way to improve the “bottom line,” ie, net income/equity partner, is to improve the “top line,” ie, revenues/lawyer. However, many firms that have had flat revenues for a while feel that there's nothing they can do to increase revenues so they start cutting expenses without regard to the affect these cuts will have on revenues. While this approach may improve profitability in the short run, it will eventually reduce profits because, when a firm focuses on cutting expenses to the exclusion of increasing revenues, its revenues soon begin to decline faster than its reduction in expenses.

Ways To Increase Revenues/Lawyer

There are a myriad of ways to increase revenues per lawyer. Here are some of them.

• Keep the same number of lawyers but increase total firm revenues. Start by cross-marketing to current clients.
• Reduce the number of lawyers but maintain the same total revenues.
• Increase the average billable hours (BHs) per lawyer without cutting rates. While there is obviously a limit as to how many BHs a lawyer can work, the fact is that, in many firms, some of the lawyers don't work very hard. Even a negligible increase in the average BHs can make a substantial improvement in profitability.

EXAMPLE: If each lawyer in a 20-lawyer firm produces just two additional billable hours a week at an average rate of $150 and works 48 weeks a year, revenues will increase $288,800 ' all of which would drop to the bottom line. If the firm has 10 partners, NI/EP will increase $28,800.

• Increase standard rates without increasing average BHs. Many lawyers are afraid to do this but experience has proved that, except for a few commodity-type practices, it can be done. EXAMPLE: If the 20 lawyers above average 1,600 BHs a year (a modest figure), a $5/hour increase in their hourly rates will increase revenues and profits $160,000 and the NI/EP will increase $16,000 ' without an increase in billable hours.
• Recruit lateral entries ' associates and partners ' with higher revenues/lawyer than the firm's current average.
• Utilize contract lawyers for peak work periods rather than hiring more associates.
• Increase leverage. Hire more associates and paralegals. Also improve productivity by greater use of technology, which is another form of leverage.
• Develop the higher-fee and more profitable practice areas. This could involve “recycling” certain lawyers into other practices, ie, from insurance defense into other commercial litigation or family law.

Increase Realization

Many firms calculate realization incorrectly by comparing collections to billings. To calculate total realization, divide collections by the dollar value of billable time (DVBT) before write downs and write offs. Well-managed firms have a total realization of at least 92%. There are a number of steps a firm can take to reach this figure or even higher.

• Review each lawyer's standard rates to be certain they are realistic, based on the market, not on the lawyer's income. Then bill at those rates.
• Work as efficiently as possible. Avoid write-downs for inefficient use of time.
• Bill promptly and regularly or, as one managing partner puts it, “While the glow of appreciation still shines in the client's eyes.” Well-managed firms ensure that time sheets are received on time. They then return pre-bills to the attorneys by the third working day of the month and require they be reviewed and returned to the billing clerk in 5 days. After preparing the final bill, the billing department mails it out directly instead of returning it to the billing lawyer to send out. Furthermore, these firms enforce the policy that, if the pre-bill is not returned to the billing department in 5 days, it becomes the final bill and is mailed to the client. The result of these policies is that bills go out by the 15th of the following month if not before.
• If a matter is completed in mid-month, prepare and send the final bill within a few days instead of waiting for the regular billing cycle. In this case, the bill should come from the billing lawyer with a cover letter.
• Except for contingency matters (see below), keep work-in-process (WIP) to a minimum by reviewing WIP regularly. Well-managed firms rarely have WIP of more than 2 months of collections.
• Follow-up on accounts receivable. Send a reminder notice at 30 days. Begin follow-up calls by a staff person ' not the billing attorney ' at 45-60 days. Well-managed firms keep their AR below 2.5 months of collections. Furthermore, the over 90-day receivables should never exceed 25% of the total AR.
• If not already doing so, take contingency matters ' but have a thorough intake and review policy to avoid unwise decisions. Record the DVBT and the eventual collections of both fees and expenses for all contingency matters. While some matters or cases may not even recover expenses, over a period of time the firm's total contingency work should produce at least $2 for every $1 invested. That's a realization of 200%!
• Introduce more fixed-fee arrangements for recurring matters in which the required time can be budgeted and controlled.
• Fire or refer elsewhere unprofitable and slow-paying clients.

Reduce Expenses Judiciously

Rather than taking an axe to cut expenses without analysis of the impact on revenues, smart firms analyze certain areas and use a scalpel. For example:

• Get rid of “unproductive” lawyers ' but be certain that, while they may not be economically productive, they are not productive instead in other important ways.
• As difficult as it may seem, start with the partners. Almost every firm has a few partners whose lack of productivity is pulling down firm profitability.
• Analyze your office lease and space needs. Sublet unused space. Shop around and move to less expensive space. Don't hesitate to try to renegotiate the existing lease.
• Shop around for loans and lines of credit. If you find a better deal ' and the chances are that you will ' discuss with your current bank before leaving them. Many times they will improve their terms rather than lose a good customer.
• Don't renew insurance policies automatically. Review them to see if you need all the coverage you currently have. Also shop around and obtain quotes from other carriers.
• Some firms still pay the entire cost of their employees' health insurance. Require them to pay a part. Also increase co-pays.
• Review the firm's mailing list(s) for lost clients or deceased contacts. Require the lawyers to “sweep” these lists at least once a year.
• Invite employees to submit ideas on how expenses can be cut or efficiency improved. Support staff can often spot unnecessary and wasteful expenses as well as inefficient procedures better than the lawyers or even the firm administrator can.

Of course not every one of the above steps can be implemented by every firm ' but many of them can be if only firm management will take the time and effort to address the profitability issue correctly. After all, it's a matter of dollars and cents.

Robert Denney is President of Robert Denney Associates, Inc., a firm that has provided management, marketing and strategic planning services to over 700 law firms throughout the United States. He has written five books on management and marketing, two of which were published by the American Bar Association. The firm's Web site is http://www.robertdenney.com/. Mr. Denney can be reached at [email protected].

Let's begin with a short quiz. Two firms each have $20 million in revenues. One firm has 40 equity partners. Its cash-basis profit & loss statement shows a profit of $8 million, 40%. The other firm has 15 equity partners. Its cash-basis P&L shows a profit of $6 million, 30%. Which firm is the most profitable?

Answer: The second firm.

There is no trick here. Many lawyers measure their firm's profitability the way a company does ' as a percentage of sales. However, the correct way to measure the profitability of a law firm, whether it is a partnership or a professional corporation, is the net income per equity partner (NI/EP) (or shareholder). The first firm above has a NI/EP of $200,000 ' $8 million divided by 40 partners. The second firm has a NI/EP of $400,000 ' $6 million divided by 15 partners. Therefore, when analyzed correctly, the second firm is far more profitable and makes far better use of its resources.

It is axiomatic that the best way to improve the “bottom line,” ie, net income/equity partner, is to improve the “top line,” ie, revenues/lawyer. However, many firms that have had flat revenues for a while feel that there's nothing they can do to increase revenues so they start cutting expenses without regard to the affect these cuts will have on revenues. While this approach may improve profitability in the short run, it will eventually reduce profits because, when a firm focuses on cutting expenses to the exclusion of increasing revenues, its revenues soon begin to decline faster than its reduction in expenses.

Ways To Increase Revenues/Lawyer

There are a myriad of ways to increase revenues per lawyer. Here are some of them.

• Keep the same number of lawyers but increase total firm revenues. Start by cross-marketing to current clients.
• Reduce the number of lawyers but maintain the same total revenues.
• Increase the average billable hours (BHs) per lawyer without cutting rates. While there is obviously a limit as to how many BHs a lawyer can work, the fact is that, in many firms, some of the lawyers don't work very hard. Even a negligible increase in the average BHs can make a substantial improvement in profitability.

EXAMPLE: If each lawyer in a 20-lawyer firm produces just two additional billable hours a week at an average rate of $150 and works 48 weeks a year, revenues will increase $288,800 ' all of which would drop to the bottom line. If the firm has 10 partners, NI/EP will increase $28,800.

• Increase standard rates without increasing average BHs. Many lawyers are afraid to do this but experience has proved that, except for a few commodity-type practices, it can be done. EXAMPLE: If the 20 lawyers above average 1,600 BHs a year (a modest figure), a $5/hour increase in their hourly rates will increase revenues and profits $160,000 and the NI/EP will increase $16,000 ' without an increase in billable hours.
• Recruit lateral entries ' associates and partners ' with higher revenues/lawyer than the firm's current average.
• Utilize contract lawyers for peak work periods rather than hiring more associates.
• Increase leverage. Hire more associates and paralegals. Also improve productivity by greater use of technology, which is another form of leverage.
• Develop the higher-fee and more profitable practice areas. This could involve “recycling” certain lawyers into other practices, ie, from insurance defense into other commercial litigation or family law.

Increase Realization

Many firms calculate realization incorrectly by comparing collections to billings. To calculate total realization, divide collections by the dollar value of billable time (DVBT) before write downs and write offs. Well-managed firms have a total realization of at least 92%. There are a number of steps a firm can take to reach this figure or even higher.

• Review each lawyer's standard rates to be certain they are realistic, based on the market, not on the lawyer's income. Then bill at those rates.
• Work as efficiently as possible. Avoid write-downs for inefficient use of time.
• Bill promptly and regularly or, as one managing partner puts it, “While the glow of appreciation still shines in the client's eyes.” Well-managed firms ensure that time sheets are received on time. They then return pre-bills to the attorneys by the third working day of the month and require they be reviewed and returned to the billing clerk in 5 days. After preparing the final bill, the billing department mails it out directly instead of returning it to the billing lawyer to send out. Furthermore, these firms enforce the policy that, if the pre-bill is not returned to the billing department in 5 days, it becomes the final bill and is mailed to the client. The result of these policies is that bills go out by the 15th of the following month if not before.
• If a matter is completed in mid-month, prepare and send the final bill within a few days instead of waiting for the regular billing cycle. In this case, the bill should come from the billing lawyer with a cover letter.
• Except for contingency matters (see below), keep work-in-process (WIP) to a minimum by reviewing WIP regularly. Well-managed firms rarely have WIP of more than 2 months of collections.
• Follow-up on accounts receivable. Send a reminder notice at 30 days. Begin follow-up calls by a staff person ' not the billing attorney ' at 45-60 days. Well-managed firms keep their AR below 2.5 months of collections. Furthermore, the over 90-day receivables should never exceed 25% of the total AR.
• If not already doing so, take contingency matters ' but have a thorough intake and review policy to avoid unwise decisions. Record the DVBT and the eventual collections of both fees and expenses for all contingency matters. While some matters or cases may not even recover expenses, over a period of time the firm's total contingency work should produce at least $2 for every $1 invested. That's a realization of 200%!
• Introduce more fixed-fee arrangements for recurring matters in which the required time can be budgeted and controlled.
• Fire or refer elsewhere unprofitable and slow-paying clients.

Reduce Expenses Judiciously

Rather than taking an axe to cut expenses without analysis of the impact on revenues, smart firms analyze certain areas and use a scalpel. For example:

• Get rid of “unproductive” lawyers ' but be certain that, while they may not be economically productive, they are not productive instead in other important ways.
• As difficult as it may seem, start with the partners. Almost every firm has a few partners whose lack of productivity is pulling down firm profitability.
• Analyze your office lease and space needs. Sublet unused space. Shop around and move to less expensive space. Don't hesitate to try to renegotiate the existing lease.
• Shop around for loans and lines of credit. If you find a better deal ' and the chances are that you will ' discuss with your current bank before leaving them. Many times they will improve their terms rather than lose a good customer.
• Don't renew insurance policies automatically. Review them to see if you need all the coverage you currently have. Also shop around and obtain quotes from other carriers.
• Some firms still pay the entire cost of their employees' health insurance. Require them to pay a part. Also increase co-pays.
• Review the firm's mailing list(s) for lost clients or deceased contacts. Require the lawyers to “sweep” these lists at least once a year.
• Invite employees to submit ideas on how expenses can be cut or efficiency improved. Support staff can often spot unnecessary and wasteful expenses as well as inefficient procedures better than the lawyers or even the firm administrator can.

Of course not every one of the above steps can be implemented by every firm ' but many of them can be if only firm management will take the time and effort to address the profitability issue correctly. After all, it's a matter of dollars and cents.

Robert Denney is President of Robert Denney Associates, Inc., a firm that has provided management, marketing and strategic planning services to over 700 law firms throughout the United States. He has written five books on management and marketing, two of which were published by the American Bar Association. The firm's Web site is http://www.robertdenney.com/. Mr. Denney can be reached at [email protected].