Take The Mystery Out Of Financial Metrics

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Every law firm is a business, and every business should know where it’s going. Like the driver of a car, a lawyer must look out the window to see what’s ahead (analogous to identifying new matters for generating additional revenue) while glancing at the dashboard to make sure all indicators (in this case, of financial performance) are positive.

Admittedly, today’s financial information systems and software can and do produce extremely detailed assessments of financial performance. However, many of these programs tend to provide far more data than can be assimilated intelligently.

When you take your car to the shop, the mechanic gives you a detailed picture of performance under the hood by hooking up engine analyzers, lab scopes, compression gauges, onboard computers and a host of other equipment. When you’re driving, though, all you want to do is glance at the dashboard and see how fast you’re going, whether the engine’s running hot or cold and how much gas you have left.

In terms of financial metrics, the dashboard glance covers financial benchmarks that help law firms measure their business effectiveness by analyzing profitability, cash flow and collections. Lawyers who understand financial benchmarking can explore operating efficiencies in the firm, gauge the firm’s performance relative to its financial goals, and better assess and reflect value to clients in their bills.

For effective benchmarking, three measurements are paramount:

  • Profitability

    Financial benchmarking focuses on profitability. In simple terms, profit can be determined by taking the total annual gross revenue by client and subtracting the costs associated with serving that client, including how long the firm has to wait for the payments.

    Relevant factors include: billing rates, the percentage of an average work week that a lawyer bills, the amount of time actually billed and collected, the ratio of non-partners (associates, paralegals, staff) to partners and expenses as a percentage of revenues.

    The key to any firm’s profitability is integrating how many hours you bill with how much money you collect. The goal is to have a high collected-to-billable ratio, well over 90 percent.

  • Realization

    Analyze realization on two levels: the billed-to-billable ratio (percent of hours billed), and the collected-to-billed ratio (percent of billed work collected).

    A good method for estimating is the accounting measure of turnover ratio: accounts receivable balance divided by the result of billings per days in the billing period. The turnover ratio tells a lawyer to expect payment for billings X number of days after a client receives a statement. The average for law firms can be as much as 120 to 150 days.

  • Cash flow

    A rolling 12-month statement of cash receipts and payments is the third key element of financial benchmarking. That directly relates to collections. One study shows that a bill over 60 days past due can still be collected about 89 percent of the time; however, that drops to a 67-percent likelihood of collection after six months, and a 45-percent likelihood after one year. A current cash flow statement highlights delinquents so you can move quickly to collect overdue accounts.

Make it visual

The final challenge is to keep track of the key metrics. The most practical approach is to use software that makes the assessment process virtually automatic and points out major variances for attention.

For example, a law firm can focus on PPP (profit per partner), billing turnover rates (how frequent is the accounts receivable turning) and a host of other important financial measurement tools.

The “dashboard” concept can be applied to the benchmarked financial information compiled by software programs, with important financial metrics displayed in an easy-to-understand visual format for use by firm management, or simply for a lawyer’s personal review.

The illustration of each metric should be visually appealing, presented either as bar graphs or line charts. You should minimize the information in each visual — no more than the current 12-month trend plus the same month of the prior year, with longer timeframes where appropriate. A graph of profits per partner, for example, might show five years of results.

The most important goal of creating and evaluating a financial dashboard is to spot problems quickly and adjust the firm’s activities so that financials remain positive. When properly displayed in an understandable format, the dashboard can take the mystery out of financial data, even for lawyers whose undergraduate and law school training lacked practical business focus.

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