Many lawyers in solo and small firm practice insist that law is a “profession” and not a “business,” an attitude that is ingrained in legal training. Lawyers typically enter law school with an undergraduate degree in the liberal arts. Law school curricula have little business focus, and too many legal educators consider any business training to be trade-oriented and therefore beneath them, an attitude that is perpetuated throughout a lawyer’s lifetime. The result is that lawyers fail to understand the operation of the firm as a business, with a budget, collections, profit and loss. Not surprisingly, this leads to the business failure of too many firms.
The issue here is one of running a law firm in a businesslike way that improves the professionalism of the practice of law. The purpose is not simply to get more money for the lawyer; it also benefits the client. Small firm lawyers who understand business competency can better assess the value they provide, and better reflect that value in their bills. They begin to think in terms of anticipated technology purchases, staffing plans, expense reductions that can be passed on to their clients. They develop an appreciation of where costs can be controlled and where costs are inherent. In short, they become cost-effective small businesses, and value-added resources to their clients.
Two sets of tools facilitate business management of law firms. One is procedural, one is statistical, and both are essential for The Business of Law.®
By the Book: Firm Procedures
Documenting policies and procedures can be a practical tool to help any law firm assess its operation against objective standards and have a rationale for its actions. Lawyers who formalize their firm’s operation in this way can implement operating efficiencies and improve the firm’s performance relative to its goals. A procedures manual should not be so detailed or cumbersome that it is hard to use. To create a useful document:
- Be as specific as possible, but write the procedures without using organizational jargon.
- Use short, direct sentences and keep them simple to avoid misinterpretation.
- Present guidelines as bullet points or numbered items, to convey a step-by-step process.
A few examples will show the kinds of challenging personnel situations that a procedures manual can help the firm manage effectively and with minimal problems.
Define policies for weather-related absences—when and how often employees can be out, whether vacation days must be used, what kind of notice should be given, especially when employees must stay home to care for children if schools are closed. Include in the manual a call-in number or texting protocol for alerts on the firm’s status in weather-related closings.
Have a severance policy for non-partner lawyers, as written guidelines that describe the procedures for evaluating a lack of or deterioration in service or performance. Have a standard severance package based on length of service, reason for termination and other considerations.
Develop a comprehensive job description for every position in the law office to promote consistent performance and objective review. Include the specific, significant tasks of each position and the standards used to judge performance. This avoids any perceived unfairness in evaluation, promotion or termination.
Document all cash management best practices. That should include procedures for who and how to handle depositing all client receipts that are not electronically transmitted, and reconciling all electronic or physical bank statements. Several persons should be identified, trained and rotated on these functions.
Develop a checklist to include mutual agreement on the nature of the ready-made book of business that the firm expects will come with the lateral hire. Document the status of the new hire’s receivables—what comes with the lateral and what stays with the prior firm.
State that a bonus should be a reward for exceptional performance in a defined period of time. The performance should meet specific criteria to clearly explain what “exceptional” means, and satisfying those criteria in one time period should create no guarantee of future bonuses.
Define when travel is necessary (such as attendance at a deposition or closing, or pitch for new client business) and when it is not (as for a seminar or a retreat). State the documentation needed for all travel expenditures and use ROI to rank such factors in the order of financial preference.
By the Numbers: Financial Benchmarks
Today’s financial information systems and software can and do produce extremely detailed assessments of financial performance. However, many of these programs tend to provide far more data than can be assimilated intelligently. What firms need is to establish financial benchmarks that measure business effectiveness by analyzing profitability, cash flow and collections. For effective benchmarking, three measurements are paramount:
Financial benchmarking focuses on profitability, determined by taking the total annual gross revenue by client and subtracting the costs associated with serving that client, including how long the firm has to wait for the payments. Track these items:
- Billing rates, whether hourly, blended (an average), fixed fee or other measure
- Utilization, the percentage of an average workweek that a lawyer bills
- Realization, the amount of time actually billed and collected
- Leverage, defined as the ratio of non-partners (associates, paralegals, staff) to partners
- Expenses, related to both operations and compensation, as a percent of revenues.
Analyze realization on two levels: the billed-to-billable ratio (the percent of billable or booked hours billed), and the collected-to-billed ratio (percent of billed work collected).
The turnover ratio: Billings divided by the total accounts receivable balance multiplied by 365.
The accounts receivable turnover is the billings for the month divided by the outstanding accounts receivable. This tells a lawyer to expect payment for a billing X number of days after a client receives a statement. The average for law firms can be as much as 120 to 150 days. Improving this ratio improves one’s cash flow, which improves profitability.
3. Cash Flow
A rolling 12-month statement of cash receipts and payments is the third key element of financial benchmarking. Benchmark analysis is a process of identifying and deducting the expenses of the practice from monthly cash received. Fixed expenses involve staff salaries, occupancy and equipment costs, outside services and the like. The largest single variable expense should be the partner or shareholder’s draw or salary. The most sensible practice is to increase it only as the firm’s performance produces sufficient income to do so.
Be sure also to highlight collections, particularly those accounts 60 days or more past due, so that the firm can take firm action to secure payment. The more client invoices that are outstanding, the more cash will be needed while waiting for payment. The issue is one of capital turnover. This defines how often the invested assets of the firm are being returned in revenues. The faster clients pay, the better the turnover ratio.
By the Way . . .
We have made the case here for procedures and benchmarks, but these should not replace evaluation of qualitative factors in the firm’s performance. Decisions based only on rules and numbers do not always address the full picture of how satisfactorily a firm is performing for lawyers and clients. Consider this dilemma. If a lawyer is sitting on a plane or waiting at the courthouse in order to handle a matter for Client A, can he or she use that time to do work for Client B? If firm rules or financial guidelines require splitting hairs like this, it depreciates client service. Again, every law firm is a business and every business should know where it’s going. But we should never forget the quote attributed to Lincoln: “A lawyer’s time and advice are his stock in trade.” Without quality advice, and the value it provides, rulebooks and numbers printouts are poor measuring sticks.
“Managing the Law Firm Business-By the Book, By the Numbers,” reprinted with permission from Law Practice Torday, 2013© by the American Bar Association. All rights reserved. This information or any or portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.