Working harder but making less money? Analyze the 5 factors of profitability

By: Andrea Johnson
Published: May 14, 2018

The legal marketplace is showing every sign of maturity with increased mergers, finite demand, oversupply, commoditization, and intense price competition. That means it’s long past the time, says Ellen Freedman, for solo and small law firms to pay attention to key profitability indicators. It is knowledge you must have to run a successful small law firm.

Freedman should know. As founder and president of Freedman Consulting, Lansdale, PA, she has spent two decades helping lawyers operate their firms at a profit, and as law practice management coordinator for the Pennsylvania State Bar Association, she has spoken extensively about the subject.

She says that while firms must be proactive and purposeful to succeed in today’s marketplace, she’s observed that they’re reactive and retrospective.

“They spend more time deciding whether to renew a $20 magazine subscription for the reception area than thinking about whether any department can be improved by upsizing, downsizing, or automating,” she laments. “They’re not thinking strategically. They frequently think volume equals profit. But it’s too easy to work yourself into bankruptcy by investing time in clients who aren’t profitable. When that happens, the more work you do, the poorer you’ll get.”

To avoid this, Freedman urges lawyers to use the five factors of profitability and analyze law firm KPIs in their practice.

Determine how many productive client-work hours each employee produces, regardless of whether they’re working on a billable hourly basis. Divide billable hours recorded by total hours worked by each attorney in the firm. This will let you know whether time is falling through the cracks. The higher the percentage of worked hours is captured, the better. Lawyers who fail to capture 80% to 90% of the hours they work on behalf of clients need to improve their timekeeping skills and tools. Lawyers who are underutilized can be given more work.

“If you bring in a dollar of revenue and it costs 50 cents to produce that (excluding owner earnings), the partners will be able to reinvest or pay themselves the remaining 50 cents out of every dollar,” explains Freedman. “I have seen firms with profit margins as low as 15 to 25 cents on the dollar. The sweet spot is 45 to 55 cents on the dollar.”

“This is nuanced,” says Freedman. “There’s the hourly rate you quote to clients, the hourly rate you actually get to bill after write-downs, and the hourly rate you ultimately collect after write-offs.”

Firms want to ensure the hourly rate quoted and the hourly rate collected are as close as possible. If not, time capture, billing procedures, and receivable management might all need improvement.

This is anything that allows you to drive revenue more efficiently. Freedman cites use of client portals as an example.

“Frequently, clients require hand-holding, particularly consumer clients in areas like family and criminal law. So, you could end up paying staff to spend endless amounts of time with clients to make them feel better – and if you don’t, those clients will go down the street,” she explains. “Or, you could give them access to information about their case through a secure client portal. Whenever they have concerns, they can log into it, look at the calendars, the documents, the assignments, the correspondence – whatever you choose to give them access to. They can gain peace of mind without reaching out to anyone. So those clients will call far less often, and your staff will gain time to accomplish client work.”

“Of every hour you work, how much do you successfully record? Out of every hour you record, how much do you successfully bill? And how much of every hour that you bill do you successfully collect?” asks Freedman. “Some lawyers routinely hemorrhage 40% to 50% of their billable hours because of sloppy timekeeping habits, not using readily available tools to automate timekeeping, or purposefully not capturing time because they think someone else could have done it faster. Another important factor is proactively managing accounts receivable.”

To get to many of these profitability measures, it is helpful to run your firm with law practice management software that has a built-in financial performance dashboard as well as financial performance reports you can run yourself. These systems hold all of your matter data, time records, and invoice and expense data so you can easily report on this information.

Applying the five factors of profitability to your firm is the starting point to thinking proactively, purposefully, and strategically, says Freedman. “You’ll quickly see what actions you must take to drive the revenue you need to succeed in today’s challenging legal marketplace,” she insists.