The business objective of profit is simple: the amount of revenue gained from a business activity should always exceed the expense. In order for law firms to remain profitable, managing partners need to be able to make critical decisions about business relationships within their firm – a concept that isn’t always explored in law school. Considering rising operating and technology costs, growing competition from other law firms and non-firm legal providers, and increasing competition for lateral partners, it is no wonder that managing profits has become a huge priority for most law firms.
So, what can managing partners do to ensure their law firm is properly managing profitability? Here are some thoughts:
1. Think Like a Business Owner. Just because law firms are traditionally structured as partnerships does not mean they cannot operate like traditional businesses. Fundamental business activities, such as developing a strategic plan, maintaining a business platform and infrastructure, managing business development, and incentivizing a compensation system can be easily translated for use in a firm setting. Like any good business owner, it’s important to annually review and consider your standard hourly billing rates.
2. Keep an Eye on Intake. Law firm profitability starts with matter intake. Make sure the firm is properly monitoring its intake of cases and clients in order to reduce potential write-downs and write-offs. Law firms should implement a well-defined intake process. Remember: one bad case can negatively affect profitability for the year. It’s also important to analyze the profitability of the client-base annually and know when to part ways with unprofitable clients.
3. Know the “R.U.L.E.S.” Follow this timeless acronym to help examine your firm’s potential profitability:
- Realization – The amount of time worked that is billed (billing realization) and the amount of time billed that is collected (collection realization) play a vital role in controlling profitability. Always remember that contemporaneous time entry matters. Understanding the influence of these ratios on firm profitability is a task every managing partner should take very seriously.
- Utilization – Comparison of billable hours to budgeted billable hours. The higher the ratio, the busier the staff. Focus efforts on billable tasks and minimize time performing non-billable tasks.
- Leverage – Law firms must understand the benefits of properly assigning matter work to the right person at the right rate. This not only saves the firm money, but it also broadens skill sets and improves productivity. Improving leverage also means partners will focus on the most profitable matters, thereby improving profit per hour and overall firm revenue.
- Expense Control – It is true that in most cases you have to spend more to make more, but this can get out of proportion easily. Always make sure that overhead is being managed and maintained.
- Speed of Billing and Collection – Actively monitor all work-in-progress and accounts receivable. The faster the bills go out, the faster the cash comes in.
4. Alternative Billing Arrangements. One thing is certain: alternative billing arrangements are not going anywhere. Be sure to have a strategy in place for this. Calculate the time and cost per hour of the firm’s fee earners in order to decide which types of arrangements work best for the client – and the bottom line.
5. Firm Culture. Studies have shown that creating a strong and positive culture leads to better morale and higher productivity. Higher productivity leads to higher profitability. When it comes to recruitment and retention strategies, law firms should always be asking themselves: what makes our firm attractive to potential new hires? Is the current culture strong and reflective of the current business environment? Managing partners should also recognize that it takes approximately two to three years for a low-level staff member or associate to become profitable; and the more mentoring and training the individual receives, the more productive and profitable he or she is likely to become.
These ideas have only skimmed the surface of what law firms can do to manage their profitability. Managing partners and executive teams should not leave anything on the table. Explore every route possible to find better ways to maximize and manage current and future profitability.