This month’s column is going to focus on profitability. Unless you are making more money than you can spend from clients who are happy to pay all of their fees on time, then it is time to review some of your procedures to see where you need to make changes to improve your finances.
In fact, reviewing your procedures is something that you should do with some regularity.
As I have been saying since we started doing the Hanging Out A Shingle program 20 years ago, being a solo or small firm practitioner is not an excuse for poor management. And this is even truer today than it was two decades ago.
Good management is even more critical than ever to financial success and easier to achieve with new technologies. Good management may not actually make you more money, but poor or inadequate management will hurt your finances.
According to the article, “The New Normal: Restoring Profitability,” in the July/August, 2012 issue of the ABA Law Practice Magazine, Arthur G. Greene says “lawyers will no longer be able to achieve financial success while operating with sloppy or ineffective business practices…Law firms that are not able to conform to good business practices are becoming victims of Darwin’s theory of the survival of the fittest.”
This is just as true for solos and small firms as for big firms.
Although not as common among solos and small firms as it is among larger firms, I sometimes get questions about whether there are any financial statistics to see how they compare to other solo/small firms. Unfortunately there is not a lot of information for solo and small firms. In the “New Normal,” article, Greene suggests that instead of attempting to compare your financial health, it is better to look inward and compare “your firm’s actual revenue to its revenue capacity.”
Although not perfect, I like this approach because comparisons with others can be difficult because there are so many variables.
Greene describes this “revenue capacity” analysis as “determining the amount of revenue your firm should be able to generate with its lawyers and paralegals working at their highest and most efficient level, given your firm’s current support, systems, and technology,” which means how much can you actually make in a perfect workplace. Once you determine that amount, compare this with your actual revenue.
This type of analysis can be done for solos and any small firm. Greene does warn that the hours used should be realistic – no one is going bill 3,000 hours. Assuming that you will bill hourly, to determine what you can earn, multiply the realistic number of hours you can bill or expect your staff to bill by your/their hourly rate. In a perfect world, that is how much revenue you can expect.
Once you calculate expected revenue – realistic given your market, practice area, workload, staff, etc. – you can compare it to your actual revenues. Ideally it should be close.
If it is way off, then you can start to determine where changes need to be made, and although that will be the hard part, this is at least a starting point.
This is a much better place to start than in comparison with others where the variables may be incredibly different. For more information on this formula, “The New Normal: Restoring Profitability” is available online.
Knowing Where You Stand
With today’s technology, there is no reason why practitioners do not have detailed financial reports. These financial reports should be reviewed at least monthly, and in some cases, as with accounts receivable, they should be reviewed more often.
These reports are invaluable to help practitioners determine why their potential revenue is not equal to or even close to their actual revenue. In addition to the traditional financial reports – such as revenue and expense budget, billable hours report, aged work-in-process report, billing realization report, aged accounts receivable report – there are other less obvious reports that will help you improve your profitability.
If you keep good records of your clients, you should also know information about where they come from, who referred them, their profitability and the time spent on their matter, and if they referred you business.
You should know which referral sources send you the most cases and those who send the most (and least) profitable cases.
You should know which practice areas are the most profitable.
Once you know this, you should devote more time to sources that send you good cases and determine how to get more of the more profitable types of cases. This information will also help you make a decision as to whether or not you want to continue to take work that has proven less profitable.
All firms, no matter how small or how new, should have a written annual and monthly budget. This budget should be reviewed regularly. Ideally, you should work with an accountant familiar with law firms of your size. Your budget should include all fixed expenses for the coming year on a month to month basis.
You should know when all of your accounts payables are due. This will help with cash flow. You should have a spreadsheet listing all of your fixed expenses, the amounts due and dates due. No A/P should be paid without partner approval.
You should have a projected budget for non-fixed expenses such as education, publications, marketing/client development, supplies. If you have been in practice for a few years, you should be able to know what you spent each year on these expenses to make an estimate for the coming year. You should be able to compare months and years to determine differences or when there may be a greater need for cash.
People Who Help
All firms no matter how small need some type of staff and advisors to make certain they are making the right business and management decisions. It is always important to have a good financial advisor or accountant. This should be someone who works with solo and small firm lawyers. This person should be an advisor and business consultant and not a bookkeeper. This person should help you create a plan to be more profitable and keep you from going too far off the track. No practitioner should start or run a practice without someone to consult for business and financial issues.
All firms should have someone who does the bookkeeping on a monthly basis. While most accounting packages make it much easier to do the bookkeeping, this is not where practitioners should be spending their time. This does not need to be a full time person and may not even need to be an employee, but there should be someone else doing the work.
In addition, all firms and practitioners must monitor all staff who works with billing, collections, or financial records. All accounts must be reconciled monthly and reviewed by a partner. If there is more than one partner, this responsibility should be alternated to avoid fraud.
On top of all the responsibilities that solo and small firm practitioners have, these management tasks can seem overwhelming. If you are not already doing some or most of these items, it may seem overwhelming. However, good management is absolutely necessary to providing good work for your clients and a profitable practice for you and your staff.