Which of your departments makes the most profit? Most firms have one or two teams who appear to be on the crest of a wave, bringing in heady deals with big figures attached to them. But do they actually translate into profit? Could it be that the ‘steady as she goes’ solicitors are actually making more money than their glamorous colleagues?
When we start working with a law firm they always know the profitability of the firm as a whole, but few really understand the drivers behind that profit. Most firms have applied traditional accounting rules across the firm – such as debtor days, WIP (work in progress), headline billings and expenses.
But these miss out the impact of a huge range of variables that affect profit by departments. As just two examples, what is the value of the lock-up of cash in no win/no fee deals or property deals that take years to complete? How are these impacting profit of those particular deals?
Most firms we work with already have their day to day accounts well managed and some basic month end reporting, but then say, well can you take it to ‘the next level’. Not really knowing what that next level looks like but wanting more from their accounts. What is interesting is when we start discussing profit drivers, they become very excited and want to go much deeper into the art of the possible, especially how to support department heads with the right information to manage their teams – not leave it all to the FD.
1. Accounting can change culture
However, care has to be taken to ensure that an accounting system does not start destroying the culture of a firm. James D Cotterman of Altman Weil, Inc explains some of the dangers well in his article on Calculating profitability.
He looks at the collegial nature of law firm partnerships: “Scrutiny of each practice and client can be a divisive issue. In addition, law firm partners generally are not well schooled in finance and accounting, so delving into cost allocations is outside their comfort zone. Finally, for many years the accounting systems and personnel in law firms were not robust and experienced enough to undertake this analysis.”
Well now accounting systems are robust enough, what should you be measuring?
Traditional accounting systems tend to be backward looking – they tell you what happened last month, give you a percentage recovery, a feel for utilisation in the firm. What they aren’t doing is look at the value of your fees relative to the work input, but most of all they should be a tool to plan and improve the future. If you know on a daily basis which clients or types of work are yielding the most profit – or costing the firm – management can see when they need to step in and help manage a client problem and over the longer term have proper conversations about the types of clients you want more of and stop the work that is draining profits.
And of course, quality information also helps to have better conversations with clients. In my last blog I looked at the 2015 LexisNexis Bellwether report ‘The age of the client’ which looked at law firms are responding to a new breed of client – more informed, more demanding and more price-sensitive than ever. Knowing where the pain points are on client work means you can look to finding better solutions to these together.
2. Top legal accounting questions
What are the questions that most managing partners eventually want answered from their Management Information system? Here are the top ones
- How does time recorded compare with what was billed?
- What is the value of debtor, WIP and disbursement lock-up? How is this affecting – and going to affect – cash flow? This can transform how an overdraft is managed with the bank
- What is the cost associated with cash tied up – not just lost interest but how could that cash have been used to grow the firm and look at new opportunities?
Typically after six months of having more information, heads of department come back with more questions, wanting to drill down in more detail such as
- Where are the issues on our fixed fee work?
- Can we identify the characteristics of our most profitable clients – so we can look at marketing to more like these?
- How can we look at cross-referrals within the firm?
While partners and solicitors can feel threatened with new reporting systems – particularly because of the ease of drilling down to individual performances – the reality is that once partners have quality information at their fingertips they start wanting more of it and using it more intelligently!
Have you seen transformation in your business once you started improving your data and analysis?