A Review of Realization

Realization is one of three metrics that affect fee revenue in a law firm. Realization in its broadest definition is fees collected divided by the value (traditionally hours ' rates) of the time worked. The other two metrics are utilization (billable hours, or how long one works) and pricing (generally hourly billing rates or what one charges for services).

These metrics affect each other. For example, I had a law firm client that was thrilled with its near-perfect overall realization. Upon examination we discovered that its high realization was due to unbelievably low billing rates, resulting in lost revenue overall. At the other end of the spectrum, large accounting firms often had realization figures in the low 80% range due to routinely large discounts off high retail rates. These are two examples, one unintended and the other planned, where realization is affected by pricing decisions.

Another client operated with an aggressive time capture philosophy ' throwing every interaction with or thought about a client into the time and billing system. In addition, we are seeing in the current recessionary environment, cases in which low work volumes can lead to a slower work pace designed to stretch the work to meet time-recording expectations. Both of these choices will affect realization later in the cycle.

Realization is also affected by staffing decisions. Poor delegation of work can easily lead to higher-rate personnel performing lower-rate work. If the partner does not adjust down the bill, clients will most assuredly push back.

Often firms will speak of realization as a monolithic metric. However, attacking realization problems requires a look at the various components. Where does the slippage occur?

1) Timekeeper discounting at the time sheet: Sometimes an inexperienced individual may discount the time entry to perform a particular piece of work, believing that it took too long to complete the task. Other times, sloppy time-capture habits, such as waiting until the end of the day (or worse) to record time, result in fewer hours recorded than actually were worked.

This is a hard item to measure because it is the un/under-reporting of time when the work is done. The availability of electronic time capture and recording software should, if used properly, greatly reduce sloppy time-capture habits as well as some of the un/under-reporting of activity. The higher realization resulting from this phenomenon leads to false conclusions about process efficiency and equally faulty decisions regarding pricing. Both can be deadly to good profitability.

2) Write-downs of unbilled time: Each firm should have and enforce policies to limit adjustments taken prior to billing. Moreover, the policies should address how write-downs are taken. Some of the typical methods of how adjustments are applied to individuals are specific time-entry identification, pro rata reductions based on proportional time value, and billing subordinates at full value while the billing partner takes the full adjustment. Methods of adjusting the accounting records include lowering billing rates (adjusting pricing), reducing time (adjusting utilization) or reducing fees (this last one is preferred and is a direct hit to realization).

What is most important is that the firm is consistent in the method it selects and that it adjusts the accounting records in the appropriate fashion. Our experience is that much of the lost realization occurs at the billing function. We have found that lawyers are often reluctant to bill for value the client would pay for. By isolating the write-downs of unbilled time ' you can calculate billing realization (the percentage of the time value recorded lost at the time of billing).

3) Client adjustments: Aggressive billing may result in greater client oversight of the invoices. This can slow down the payment cycle and increase the adjustments as clients wade their way through each time entry and cost item. Client adjustments provide the basis to calculate collection realization (the percentage of the bill that is actually paid by the client).

The product of billing realization and collection realization is overall realization. This metric is most often published in survey data and law firm reports. However, it is important to distinguish between realization rates using actual versus standard billing rates.

Pricing Variance

Generally, realization is calculated on the standard billing rate. Law firm time and billing systems also maintain alternate/actual billing rates for each timekeeper and matter. Realization based on standard rates may reflect the results of a pricing decision as well as consequences from the efficient delivering and staffing of the matter. One can report both realization figures (standard
and actual rate) and calculate the difference between the two realization rates. The pricing variance is the result of that calculation.

If you are tackling a pricing variance problem, consider the following questions. Is pricing clearly communicated to clients? Is there a mechanism to adjust pricing (periodically or if material facts of the representation change)? Is the pricing risk-adjusted? Is the pricing relative to the market for similar services? Does the pricing consider constraints imposed on the firm (time requirements, exclusivity in representation, use of developed work product and the like)? Does the pricing consider the client's payment history?

Efficiency Variance

An efficiency variance is the difference between 100% realization and realization calculated at actual rates. This measure looks at non-pricing issues affecting realization. It includes staffing decisions involving experience and expertise as well as the efficiency of the process used to deliver the services. It also reflects the nature and success of supervising the matter.

To tackle these challenges, consider whether your firm has the proper staffing profile (expertise and experience) for the work it does. Is there a work plan/budget so that variances are quickly identified? Are those supervising the matters trained and proficient in project management techniques?

View Table 1, below, which depicts realization data for the legal profession in 2008. Data will be different for different law firm size ranges as well as for different practice specialties.

[IMGCAP(1)]

The speed of collections is an important issue related to realization. We all know that the longer it takes to bill the client and the longer the client takes to pay, the more likely it is that collections and realization will suffer. Two additional measures that indicate the speed of collections are turnover of unbilled time and turnover of accounts receivable. The speed of collections affects both realization and, just as importantly, working capital needs of the firm.

Turnover of Work-in-Progress (WIP or Unbilled Time)

This measure looks at how many months of billings are sitting in inventory. Typically, we see about 2.4 months with the most profitable firms at about 2.0 months.

The following questions are helpful in sorting out how well you are managing your time value inventory. What provisions are there for retainers and advance billings? What percentage of fees is determined on a contingency or end-of-matter or some other basis?

Turnover of Accounts Receivable

This measure looks at how many months of collections are sitting in accounts receivable. It comprises both fees and costs advanced. Typically, we see about 2.2 months with the most profitable firms at about 2.0 months.

Ask many lawyers and they will say that the only issue they dislike more than telling a client how much the service will cost is to ask the client to pay for that service once a bill has come due. What policies are in place to follow up? Are there stop work thresholds (within the constraints
imposed by legal ethics and responsibilities)?

We mentioned before that working capital is affected by the speed of collections. Consider this: A 500-lawyer law firm averaging $500,000 in revenue per lawyer would save approximately $12.5 million in working capital needs with a .6 month reduction in inventory (4.0 for a top firm instead of 4.6 for a typical firm).

Examining realization is important to maintaining good fiscal health in a law firm. This article has provided the most common areas to begin review.

James D. Cotterman is a principal of Altman Weil, Inc., a legal management consultancy headquartered in suburban Philadelphia. He may be contacted at 407-381-2426 or e-mail [email protected]. Copyright ' 2010, Altman Weil, Inc., Newtown Square, PA, USA.

Realization is one of three metrics that affect fee revenue in a law firm. Realization in its broadest definition is fees collected divided by the value (traditionally hours ' rates) of the time worked. The other two metrics are utilization (billable hours, or how long one works) and pricing (generally hourly billing rates or what one charges for services).

These metrics affect each other. For example, I had a law firm client that was thrilled with its near-perfect overall realization. Upon examination we discovered that its high realization was due to unbelievably low billing rates, resulting in lost revenue overall. At the other end of the spectrum, large accounting firms often had realization figures in the low 80% range due to routinely large discounts off high retail rates. These are two examples, one unintended and the other planned, where realization is affected by pricing decisions.

Another client operated with an aggressive time capture philosophy ' throwing every interaction with or thought about a client into the time and billing system. In addition, we are seeing in the current recessionary environment, cases in which low work volumes can lead to a slower work pace designed to stretch the work to meet time-recording expectations. Both of these choices will affect realization later in the cycle.

Realization is also affected by staffing decisions. Poor delegation of work can easily lead to higher-rate personnel performing lower-rate work. If the partner does not adjust down the bill, clients will most assuredly push back.

Often firms will speak of realization as a monolithic metric. However, attacking realization problems requires a look at the various components. Where does the slippage occur?

1) Timekeeper discounting at the time sheet: Sometimes an inexperienced individual may discount the time entry to perform a particular piece of work, believing that it took too long to complete the task. Other times, sloppy time-capture habits, such as waiting until the end of the day (or worse) to record time, result in fewer hours recorded than actually were worked.

This is a hard item to measure because it is the un/under-reporting of time when the work is done. The availability of electronic time capture and recording software should, if used properly, greatly reduce sloppy time-capture habits as well as some of the un/under-reporting of activity. The higher realization resulting from this phenomenon leads to false conclusions about process efficiency and equally faulty decisions regarding pricing. Both can be deadly to good profitability.

2) Write-downs of unbilled time: Each firm should have and enforce policies to limit adjustments taken prior to billing. Moreover, the policies should address how write-downs are taken. Some of the typical methods of how adjustments are applied to individuals are specific time-entry identification, pro rata reductions based on proportional time value, and billing subordinates at full value while the billing partner takes the full adjustment. Methods of adjusting the accounting records include lowering billing rates (adjusting pricing), reducing time (adjusting utilization) or reducing fees (this last one is preferred and is a direct hit to realization).

What is most important is that the firm is consistent in the method it selects and that it adjusts the accounting records in the appropriate fashion. Our experience is that much of the lost realization occurs at the billing function. We have found that lawyers are often reluctant to bill for value the client would pay for. By isolating the write-downs of unbilled time ' you can calculate billing realization (the percentage of the time value recorded lost at the time of billing).

3) Client adjustments: Aggressive billing may result in greater client oversight of the invoices. This can slow down the payment cycle and increase the adjustments as clients wade their way through each time entry and cost item. Client adjustments provide the basis to calculate collection realization (the percentage of the bill that is actually paid by the client).

The product of billing realization and collection realization is overall realization. This metric is most often published in survey data and law firm reports. However, it is important to distinguish between realization rates using actual versus standard billing rates.

Pricing Variance

Generally, realization is calculated on the standard billing rate. Law firm time and billing systems also maintain alternate/actual billing rates for each timekeeper and matter. Realization based on standard rates may reflect the results of a pricing decision as well as consequences from the efficient delivering and staffing of the matter. One can report both realization figures (standard
and actual rate) and calculate the difference between the two realization rates. The pricing variance is the result of that calculation.

If you are tackling a pricing variance problem, consider the following questions. Is pricing clearly communicated to clients? Is there a mechanism to adjust pricing (periodically or if material facts of the representation change)? Is the pricing risk-adjusted? Is the pricing relative to the market for similar services? Does the pricing consider constraints imposed on the firm (time requirements, exclusivity in representation, use of developed work product and the like)? Does the pricing consider the client's payment history?

Efficiency Variance

An efficiency variance is the difference between 100% realization and realization calculated at actual rates. This measure looks at non-pricing issues affecting realization. It includes staffing decisions involving experience and expertise as well as the efficiency of the process used to deliver the services. It also reflects the nature and success of supervising the matter.

To tackle these challenges, consider whether your firm has the proper staffing profile (expertise and experience) for the work it does. Is there a work plan/budget so that variances are quickly identified? Are those supervising the matters trained and proficient in project management techniques?

View Table 1, below, which depicts realization data for the legal profession in 2008. Data will be different for different law firm size ranges as well as for different practice specialties.

[IMGCAP(1)]

The speed of collections is an important issue related to realization. We all know that the longer it takes to bill the client and the longer the client takes to pay, the more likely it is that collections and realization will suffer. Two additional measures that indicate the speed of collections are turnover of unbilled time and turnover of accounts receivable. The speed of collections affects both realization and, just as importantly, working capital needs of the firm.

Turnover of Work-in-Progress (WIP or Unbilled Time)

This measure looks at how many months of billings are sitting in inventory. Typically, we see about 2.4 months with the most profitable firms at about 2.0 months.

The following questions are helpful in sorting out how well you are managing your time value inventory. What provisions are there for retainers and advance billings? What percentage of fees is determined on a contingency or end-of-matter or some other basis?

Turnover of Accounts Receivable

This measure looks at how many months of collections are sitting in accounts receivable. It comprises both fees and costs advanced. Typically, we see about 2.2 months with the most profitable firms at about 2.0 months.

Ask many lawyers and they will say that the only issue they dislike more than telling a client how much the service will cost is to ask the client to pay for that service once a bill has come due. What policies are in place to follow up? Are there stop work thresholds (within the constraints
imposed by legal ethics and responsibilities)?

We mentioned before that working capital is affected by the speed of collections. Consider this: A 500-lawyer law firm averaging $500,000 in revenue per lawyer would save approximately $12.5 million in working capital needs with a .6 month reduction in inventory (4.0 for a top firm instead of 4.6 for a typical firm).

Examining realization is important to maintaining good fiscal health in a law firm. This article has provided the most common areas to begin review.

James D. Cotterman is a principal of Altman Weil, Inc., a legal management consultancy headquartered in suburban Philadelphia. He may be contacted at 407-381-2426 or e-mail [email protected]. Copyright ' 2010, Altman Weil, Inc., Newtown Square, PA, USA.