You may remember that way back when, earlier this year, we started this series, and for some reason this final part has just hung-on and never been published till now (ME BAD). Anyway this series was intended to focus on the roles and responsibilities of the ‘Trusted Advisor’ to Law Firms. I realize that a lot of accountants and ProAdvisors are expanding, focusing and perhaps even re-focusing their ProAdvisor generalist practices into ‘Epic practices’ specializing in law firms. We also recognized that law firms in big cities and small are searching for trusted advisors to provide not simply accounting and/or bookkeeping needs, but services related to their requirements related to Trust Fund management and reporting, client billing practices, case cost tracking, compensation methods, and practice management including case-tracking. As trusted advisors you may be called upon to assist those firms with a wide-variety operational procedures and best practices, in addition to helping them select and implementation software associated with their law firm’s specific requirements.
In this article we will look at the various measurement values (analytics) that apply to law firms and how those measures maybe associated with their compensation structure. Typically, a trusted advisor will need to be familiar with applicable metrics used by law practices, as well as the various methods and requirements compensation applicable to the firm's organizational and employee structure.
Law Firms Measurements and Compensation
Every business has financial information that is important to measure. There are several metrics (some would call them 'key performance indicators') that every law firm should use in order to evaluate financial outcomes in relationship to case outcomes. These analytics include, cost of servicing client(s), profitability, marketing costs as a percentage of revenue, technology expense as a percentage of revenue, realization, perceived value and benchmarks.
Cost of servicing client(s) is a measure of the overall cost associated with servicing the entire case load, but also each individual client, and it should be reflective of all costs, not just those directly associated with a client or case. This means that a percentage of overhead and fixed assets should be allocated during the computation of this metric.
Profitability. As in all businesses, the net difference between the income and expenses is the profitability of the firm. There will be fixed and variable costs. Law firms do not usually have a Cost of Goods Sold account, although some firms will classify fixed costs in this area for reporting purposes. Even though you take a variety of particulars into account, computation of law firm profitability can be a very complex, and in fact it may take the form of many different sub-measures encompassing such factors as profitability by area of practice, profitability by client, profitability by partner, profitability by associates or other timekeeper level personnel. It maybe possible to either combine aspects of these different areas of measurement in order to determine the overall firm profitability, or you may need to run a stand-alone formula to determine the firm's overall profitability.
Marketing costs as percentage of revenue can include both hard advertising costs as well as less tangible marketing expenses (which might include image factors and entertainment). In these days when 'social marketing' is the 'in' thing, don't forget to include internal as well as external (social media specialist) costs that maybe associated with your ramping up social to build your practice. Another area some firms will choose to incorporate in the overall category of 'marketing' will be referral fees, when a portion of total revenues are paid to another firm who make a referral or recommendation (in effect this is a form of marketing - compensation to others that attracts business to your firm.)
Technology expense as a percentage of revenue will not only include the hardware and software costs your firm encounters, but also all associated consulting, training, and 'orientation time' for all members of the firm. Don't just jaunt down time of your personnel as 'overhead' when they are undergoing training or coaching (or hand-holding for that matter) on the newest technology your firm has acquired. Both internal and external IT personnel expenses should also be incorporated into this metric, but when internal personnel are fulfilling this role make certain that your are appropriate allocating their time spent on technology as opposed to other firm areas. (In other words if an Associate also serves as your internal IT manager, make certain their time is properly accounted for between their technology duties and their other case and/or research load.)
Realization might better be though of as 'Rationalization'. This is a measure of how much a firm works compared with the earnings it actually realizes. Measures of this nature are intended to help you rationalize how much work is being performed in relationship to the billed revenues, so you need to consider factors like discounts, write-downs, referral fees, and write-offs for unpaid fees.
Perceived Value - this is one that you can't do on your own, it is a metric that your clients provide, typically using a survey form. You are trying to get a real sense of just how your clients 'love you' in relationship to what you 'charge them'. OK, perhaps 'love' is a strong word, but everyone who has had their lawyer 'win their big case' (whether that is to keep them out of jail, or win a personal injury award) as some special sense of affection for their lawyer (who just happens to be the 'best lawyer in history') at least until they get your invoice. It is however important to know how your clients perceive your worth and value, in other words were you really worth what it cost them.
Benchmark comparisons - simply computing your own metrics isn't enough, you need to make comparisons between your own metrics and industry specific analytics. Such benchmarks can be found in a wide variety of legal-specific information sources like the the American Bar Association, the Legal Marketing Association, LexisNexis, and others.
As if those sever were not enough, there are also some other practical measures that are important to watch in relationship to your bottom line (used in computation of many of the above metrics.) These include Advanced Client Costs, Trust Accounts, Firm Profitability and Compensation measurements.
Advanced Client Costs are important to watch, to make sure that they are reimbursed in a timely manner, or written off when appropriate. Since these expenses are usually tracked on the balance sheet, they should be closely watched. If the firm does not get reimbursed they are carrying the costs with a direct impact on cash flow. Making sure the costs are billed and reimbursed can help to improve cash flow. If the costs will not be reimbursed then they should be written off and moved to the expense side of the income statement so that the firm can at least benefit from the deduction.
Trust Accounts - We have written extensively about Trust / IOLTA accounts so will not go into detail beyond saying that it is important to make sure that the IOLTA bank account and liability account balances match and that the amounts can be clearly identified by client.
Law firm compensation can be as varied as the number and variety of law firms. While paralegals and administrative staff are usually compensated by salary or hourly wages, attorneys can be compensated in a variety of ways. When working with a firm you should understand the compensation plan so that you can make sure the appropriate measurements are available. Often firms put into place compensation plans and then spend hours doing calculations. Providing advice on how to match measurements and compensation can help the firm be more efficient and enhance your role as a trusted advisor.
Most law firms are some form of partnership and so the compensation of the partners / owners is based on the bottom line. While the partners will usually take draws during the year the final amount they can take will be dependent on the income brought in for the year and the expenses incurred. It is important to watch the amount being drawn relative to the firm cash flow and profitability to avoid excessive draws during the year.
Firm compensation can be based on hours works, who brought in the client, who brought in the matter, who is responsible for the matter, firm profitability, case profitability or a combination of the above. Many firms will track Originating attorney for both the client and the specific matter as well as responsible attorney for the matter. These attorneys may get a percentage of the billed or collected revenue, with the remaining revenue going to those who actually do the work.
As a trusted advisor to the firm you can help them understand the importance paying on collected revenue and making sure that expenses and write-offs are considered. While it may seem obvious, that the value of an attorney who works 100 hours but has to write off 25 hours is less than the attorney who only works 80 hours but bills it all, this sometimes gets lost within the firm measurement. Your role is to help the firm recognize the actual value being collected and making sure that the firm members are compensation appropriately but in a manner that can be easily calculated within the systems use.
Matching the measurement system and the compensation system will help the firm to save time and improve profitability. Computing and providing the fundamental metrics will help the law firm's principles understand just how well, or not so, their firm is doing, especially in relationship to practice benchmarks.