Law school prepares lawyers to practice law, but it often does not teach lawyers how to manage a firm. More importantly, it does not teach lawyers how to manage a profitable firm.
In today's increasingly competitive climate, many law firms find themselves at a loss when it comes to ensuring their firm remains profitable and in a position to grow. It can be challenging to understand how to calculate profitability, for starters. In addition, many factors can impact a law firm's financial health. The dizzying array of new technological solutions muddies the waters even further, leaving many attorneys too frustrated to make any changes at all.
This post will help law professionals understand the basic economic elements of a growing law firm and provide tools, tactics, and strategies you can use to ensure your firm is on a sound financial footing and positioned for growth— without the stress.
Law firm economics: Basic elements
For most businesses, determining profitability is relatively simple. For example, in retail stores, profitability is calculated by subtracting expenses from revenue. How much does it cost to make this thing and what can we sell it for? What are our overhead costs? Understanding what it takes to be profitable is relatively simple in most traditional business models.
In law firms, however, those simple elements are a bit more complicated.
Costs and profit margins are not the same across all personnel, for starters. At a firm, you are selling time and expert knowledge, not items that are easily valued. There are multiple ways to calculate profitability and even more methods to tally billable hours.
When you are working 70 to 80 hours every week, taking the time to understand the economics of a law firm might not be high on your list of priorities. (Particularly when it is not billable time!)
However, understanding the main principles of law firm economics is critical to the long-term success of your firm. Here is what you need to know.
Margins vs. contributions
The most common considerations used to measure law firm profitability are margins or contributions. At their simplest, margins are calculated by the following equation.
This is similar to the way traditional businesses track profitability.
Contributions, a less common profitability metric, is a percentage-based metric used to compare how much practices, offices, or clients contribute to the target profits per equity partner (PPEP).
Similar to a corporate retail store measuring the amount a single store contributes to overall corporate profitability, this metric is used internally to understand how certain elements contribute to profitability, but also as a comparison tool against other firms.
Contributions are often calculated using the following method.
For example, if the overall firm average contribution is 65%, a contribution level from a client of 75% would indicate that the client is above the firm average profitability.
There are benefits and challenges to each method. The contribution metric is intended to show the economic impact of a matter and allows attorneys to look for ways to strengthen that performance.
However, since margin can provide a similar comparison and is used in many other business environments, many firms are moving to calculate profitability using this method.
At their core, billable hours are the worked hours that clients pay for directly. However, they can be calculated using several methods, which can create complications.
These methods include fixed fees, blended rates, contingency fees, and success fees. Exploring the pros and cons of each method is beyond the scope of this article, but do be sure to avoid switching between billing types.
These are tasks that must be completed but cannot be charged back to a client, including professional development, administration, continued education, networking, and other errands that are crucial to the success of the firm.
It is important to ensure these tasks are truly wise investments of your time and not billable hours masquerading as non-billable hours.
Expenses & overhead
Expenses and overhead costs, and the line between the two, can make or break your firm. Expenses are costs the firm incurs during the course of a case, such as mileage, copies, filing fees and other costs that can be recouped. Overhead are costs that cannot be billed to a specific client, such as rent.
However, without proper tracking, expenses can creep into the overhead, which can drastically cut into profitability.
Law firm profitability benchmarks
Understanding how your firm makes and spends its money is essential to nearly every decision, from hiring a new associate to determining which cases to take on. However, it can be challenging to understand what the data your firm gathers indicates about its overall financial health. You might know, for example, that salaries are 70% of your firm's revenue, but what does this indicate about your firm's future?
The American Academy of Estate Planning Attorneys sets these profitability benchmarks as positive of positive law firm financial health. While these benchmarks may vary slightly in different types of law or geographical locations, they are a solid starting point for determining if your firm is on the right track.
- Revenue Per Employee Averages Between $150,000 – $175,000: Too low means your firm is not working efficiently, while too high may mean one employee is pulling in a greater percent in revenue, which could leave the firm vulnerable if that employee decides to leave.
- Revenue Per Attorney Should Average Around $500,000: This amount indicates lawyers are working efficiently and not getting bogged down in non-attorney work. If this number is low, it is time to reevaluate delegation and time management.
- Salaries: 65% Of Gross Revenue: Owners generally earn around 40% of gross revenue, leaving staff and non-partners earning between 25 and 35%. Less than this number could lead to high turnover, while slightly higher may be beneficial to increasing loyalty.
- Marketing Spend Between 8 & 10% Of Gross Revenue: To market more efficiently, consider diversifying your marketing strategy, so you aren't overly reliant on any one vertical.
- Rent: 6 To 7% Of Gross Revenue: If you spend less, this could lead to employee burnout (or indicate a very low cost of living area), while higher may indicate poor financial health. The AAEPA also suggests between 250 to 350 square feet per employee. If you rent a larger space, consider subletting a portion of the office.
Tips to improve law firm profitability (and mistakes to avoid)
If your firm fails to meet the benchmarks above, it is time to take action. The following section provides strategies and tools to move your firm towards a strong financial footing.
Maximize billable time & prevent loss of billable hours
Increasing the revenue of the firm is an important factor when accounting for the ‘success’ of a firm. While increasing billable hours is the obvious answer when looking to generate more revenue, more work isn't always the solution.
Start by looking for unaccounted-for billable hours. That is, the hours you are already working, but not charging for.
- Bill for every bit of time you spend on a case. Even if it is just a three-minute email, those 3 minutes add up. Consider this: if you send 'just' a three-minute email every day, that is more than 16 hours of time you didn't bill for per year.
- Track tasks as you go. At the end of the day, you are not likely to remember exactly what you worked on each minute of the day. Much less at the end of the week) Make it a habit to track tasks as you go.
- Use descriptive language in billing hour reports. For example, don't just list "research", but explain what you were researching. This can limit client push-back on hours later.
- Use your time wisely: Make sure you are not wasting valuable time on tasks someone else could complete. Delegate lower priority tasks to associates or paralegals and focus your hours on tasks that only you can do.
Use time tracking tools
When it comes to billable hours, many lawyers fail to track their time properly. When you are working 70 or even 80 hours a week, it can be easy to forget what tasks you completed and how much of that time really is billable hours.
Use tools, such as meeting management and legal case management software to make it easier to track time and ensure efficiency.
Effectively track profitability factors
Profitability factors are critical to building a stable firm that is primed for growth. For example, firms may find a certain practice area or type of client is far more profitable than another. Understanding where the firm is most profitable (and where you are not) can help you understand which efforts will have the most impact on your bottom line.
Leverage the data you have
Your firm likely already possess a large amount of information about how your business operates, including your most profitable clients, the hours you bill, and the average revenue per attorney. Failing to make use of this data can have a direct impact on your firm's bottom line and potential for growth.
Reviewing this data on a regular basis can provide insight into your firm's strengths and weaknesses and highlight new opportunities, such as practice areas that could open up new streams of revenue.
Improve your bottom line with practice management software
When it comes to working more efficiently, attorneys need to be at the forefront of technology. While changing the way things have always been done is challenging, new technology like practice management software can make it easier than ever to clean up non-billable hours, recoup lost time, and work more efficiently overall.
Features may include a legal CRM to track customer details, document templates, accounting and billing, time tracking, and meeting management.
Legal case management software can improve efficiency & accuracy
Legal case management software is designed to manage case and client records, billing, booking, internal communication, and even scheduling and appointments. The software is designed to be simple for support staff and attorneys to use with customizable features so firms can adapt the software to fit their specific needs.
Benefits of case management software may include:
- Increased accuracy, which increases profitability
- Increases transparency, which can raise client satisfaction and reduce write-offs
- Protection against data loss
- Makes it easier to stay organized
- Facilitates communication and reduces meetings
The future of profitable law firms is technology
Consider this: workers spend as much as 4 hours every week preparing for meetings. If you have a dozen employees, that equates to 48 hours wasted every week. Technological solutions such as meeting software or legal case management software can help your firm recoup lost time, simplify and lower overhead, and harness the power of automation.
Firms that fail to implement technological solutions will not be positioned to compete with progressive firms. Technological solutions can be confusing, especially with the wide array of options on the market; however, they can dramatically improve both client service and overall law firm profitability.