Taking the Lead: Tips to Help Demystify the Numbers

In Taking the Lead, Law Practice Editorial Board member Karen MacKay together with guest authors, tackle the ins and outs of running a law firm, providing expert guidance that every managing partner can use.

With the fourth quarter of their fiscal year upon them, most law firms are now digging into the planning process for the coming year. Sifting through numerous financial reports is, of course, a key part of the process for law firm leaders. But with so many numbers involved, where do you begin?

Many law firm leaders say financial management is among their greatest challenges, in part because most lawyers are by nature “word people.” After all, if you naturally gravitated to numbers, you would have chosen a career in commerce or accounting rather than the law.

Yet now, as managing partner, you find yourself running a sizable business, so getting your head around the numbers is critical — both to your success as a leader and the success of your firm.

Karen MacKay

by Karen MacKay, MBA, CHIC

The accounting systems used in most firms do a good job providing an abundance of data. The issue is typically how to interpret all the financial data available to you. To start, it is helpful to understand the basic questions that will affect your planning and then look at your financial information to see how it answers those questions. The following sets out a few of the more important questions and where to look in your financial reports to get the answers.

Is Your Business Growing?

Growth in a firm's activity can be measured in a number of ways. Here are examples of the measures that are relevant and understandable to the lawyers working in the firm:

  • Total new file openings. Compare the past 12 months to the previous year's figure. Did you open more or fewer files this year?

  • New matters for existing clients. Consider this number from two perspectives. Are you growing existing client relationships by doing more of their work—work that might have otherwise gone to other firms? Also, are you broadening relationships with your clients by serving them across more practice areas of the firm?

  • Effective rates. Is the effective rate you are getting for the work done by various groups of timekeepers (partners, associates, paralegals) increasing or decreasing? Whether you charge clients on a flat-fee, retainer or hourly basis, you still need to understand the hours that went into the project and set rates to reflect the value of the work being done. A rising effective rate is a sustainable lever of profitability and reflects the expertise and quality of the firm's work product.

Are You Leveraging the Firm's Talent?

In addition to rates, another profitability factor that is directly related to talent is leverage. The leverage model that will be most profitable is usually guided by the nature of your practice, and given practices may leverage a mix of associates, paralegals, staff and technology. But overall, leverage is key to profitability in any law firm. There are a number of basic indicators that you might monitor to gauge where adjustments may be needed, including these:

  • Productivity by timekeeper group. This is indicative of the workload of your partners, associates and paralegals, but remember that alone it is imperfect and incomplete information. Increased productivity at the partner level may mean that partners have attracted new and better work. Or, alternatively, it may mean that associate attrition has risen and the partners are taking back files that would have otherwise been done by associates.

  • Percentage of partner hours. This is the ratio of partners' hours worked to the total hours worked by all timekeepers. If partners are keeping associates busy, they are making room for more and better work for themselves while also keeping the junior lawyers challenged and growing. Partners with unusually high hours may be hoarding work or keeping work that should have been delegated, which puts undue pressure on rates and increases write-offs at the time of billing.

  • Associate attrition. This rate directly impacts leverage and is often connected to associate productivity—i.e., average billable hours across the associate group. When attrition goes up, productivity goes down, owing to both the wind-down of associates who leave and the need to train and ramp up the associates you hire to replace departing ones.

How Are You Managing the Business?

Even if your firm has a full-time administrator, chief financial officer or controller to run the day-to-day business side of things, you still need to steer the helm. Keep your eye on the following, and then use your influence as a leader to set the direction and align your partners behind the firm's goals:

  • Managing WIP. Focus your colleagues on some of the behaviors that can improve the management of work in process (WIP), especially how it is billed to maintain the firm's cash flow needs. In many firms, especially smaller ones, unbilled disbursements are a particular challenge. Firms regularly carry unbilled disbursements of 20 to 25 percent of their annual revenue, which means basically they are financing their clients' expenses. You should bill fees and disbursements on at least a monthly basis. Clients often complain at sticker shock when lawyers bill for the entire matter at the end of an engagement. Most clients want their matters billed regularly and in manageable amounts.

  • Collecting receivables. Well-managed firms not only bill regularly, they also collect within reasonable time frames. As you plan the coming year, focus on shortening the typical number of collection days by implementing new processes for collecting accounts receivable in a timely way. Reminder statements are part of the process, but nothing replaces focused effort on the part of the lawyer, his or her assistant and someone on the firm's accounting team.

  • Tracking overhead per lawyer. Regardless what the type of practice or the leverage model is, overhead per lawyer is an equalizer in the firm. It is a measure of how well you are managing expenses to match the firm's financial plan.

How Do You Communicate the Numbers to Your Colleagues?

Many partners say they receive regular financial information but often they don't take the time to read it—or, when they do, they don't understand what it means. Spreadsheets might be the reason your accounting people get up in the morning, but they can leave your attorneys very cold.

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A solution: Communicate as much as you can on a one-to-two page summary and where possible use graphics to convey key figures in visual form. A picture truly is worth 1,000 words and can show trends that give rise to meaningful conversations between individual stakeholders and at your partnership meetings.

With the most important numbers demystified, you can celebrate what the firm is accomplishing. You can also understand the challenges and work collaboratively to help your colleagues better understand the numbers and what they specifically need to do to improve the financial situation for the firm—and for their own pockets.

This article originally appeared in the November/December 2010 edition of Law Practice magazine, a publication of the American Bar Association. Copyright © Phoenix Legal