Law firms tend to focus on a few financial benchmarks – revenues per lawyer and profits per partner, for example. But revenues per lawyer is one-sided; since it doesn’t take into account the costs of running the firm, it yields little real information regarding the financial performance of the firm. Similarly, profits per partner (“PPP” or net revenues divided by the number of equity partners) is wholly dependent on who is classified as a partner (or more particularly, who is not — i.e non-equity partners and associates only have their net revenues included). For example, firms can change their PPP numbers by developing non-equity partnership ranks or not elevating associates to full partner status.
But there are many other financial ratios and benchmarks that can be prepared by a law firm that can yield real insights into the financial performance of the firm. Furthermore, by focusing in on a few well-chosen financial metrics, a firm can start along the path of financial strategic goal setting and achievement. In this article, we look at a selection of some of these ratios and metrics and what they can mean for a practice.
1. WIP over 180 days/total WIP:
Work in progress (WIP) represents an investment by the firm in client files. However, it is a short-term investment — it should be converted into paid billings as soon as possible to avoid the investment reducing in value. We all know that the longer WIP sits unbilled, the lower the chances of collection. Accordingly this ratio looks at the percentage of WIP that is over 180 days old as compared to total WIP. By tracking this over time, you can determine if your WIP is aging too long, and that may indicate a problem in file selection (problem clients are oftentimes not billed to avoid antagonizing the client), a problem lawyer (procrastination) or a too-great dependence on contingency files. Either way, it bears investigation when it starts going the wrong way.
2. Lawyers income as a percentage of paid billings:Lawyers constantly ask if their overhead is too high. The typical benchmark is that (gross) income should lie between 60-65 per cent of paid billings. Of course, practices vary and so do staffing levels and office rent (since staff and office rent are the two biggest components in overhead). But, if your income is too low, then you should be looking at your office efficiency and effectiveness, your daily billable hourly targets (they may be too low), and seeing if you can move to lower cost office space.
3. Total debt/net fixed assets
To what degree are you financing yourself through debt (line of credit etc.)? Increasing debt is a good way to increase your productivity — but only up to a point and only if that debt obligation is put back into the practice to increase capacity. If you have been borrowing to pay draws and other non-productive items, then you have a growing problem on your hands as the debt will become due and you have not increased your income producing capacity to handle it. By tracking this ratio over time, you can see if you are maintaining an equilibrium or sliding further into debt.
4. Realization rate
Virtually every firm carries bad debt on their books. But how much is too much? A firm that does hourly rate billing should aim to achieve a 95 per cent realization rate — collecting all but $0.05 of every dollar they bill. Unfortunately, most firms lie between an 80 to 90 per cent realization rate for hourly rate work. However, if you are a contingency fee biller, then your realization rate should be 150 per cent — to make up for the fact that some contingency files do not result in any payoff. A low realization rate typically indicates a poor client-intake and selection process — you can tighten up your client intake, improve your realization rate and work easier too.
5. Annual billable time expectations
Every lawyer in private practice should have a billable hour goal — even if they only work on contingency work. There are many reasons for so doing, but perhaps the best is that without the time put into a file, any analysis as to profitability is all but impossible. Furthermore, law firm budgets are based on lawyers achieving a certain annual billable target (say $400,000) – divide that by 231 (the typical number of work days/year) to arrive at your daily billable expectation (400,000/231 = $1,732.00). Divide that by your standard hourly billable amount (say $250) to arrive at you daily billable time expectation ($1,732/250 = 7 billable hours/day. Now you can track your daily time and see if you are meeting, falling behind or exceeding budget.
6. Effective hourly rate
Once you know the billable time put into a file: divide the fees collected on a file by the total time put into a file (which should be at least the time billed), and you arrive at your effective hourly rate. Now — here is where it gets interesting: compare your EHR to your quoted billable hourly rate — are you below, equal or above your quoted billable hourly rate?
7. Associates salaries as a percentage of their billings
By now if you have gathered that setting financial targets is a theme in this article, you are correct. Accordingly, associates should be expected to bill (not collect, as most firms allow partners to write-off associate time and that should not impact this calculation) at least three times their annual salaries. If their numbers are actually closer to four times their annual salary, then it may be time to think about a raise.
So there you have seven different financial metrics for use in a law firm. You can choose one or more as your goal over the next year – for example, to achieve an Effective Hourly Rate of $X/hour or to take home 65 per cent of your paid billings. Having your goal in mind allows you to visualize your goals and start to reach out to your future.
David J. Bilinsky is a practice management adviser with the Law Society of British Columbia and chair of the Pacific Legal Technology Conference’s planning board. The views expressed herein are strictly his and may not be shared by the Law Society of B.C.