If you reading this, you are probably a senior/junior partner in your law firm, or you manage a team of several attorneys.
Through your work career, you aspired to become an as best lawyer possible. You went to law school; you passed the bar, got yourself a job in a good law firm, and excelled in providing professional services to your clients. Now, when you got to a management position, the game is a bit different: you need to acquire both hard and soft skills for managing a company.
In this text, we will cover the hard part, covering the finance issues of managing your law firm. We will present you with 15 essential metrics for managing law firms. Sit back, enjoy our text and we hope you will choose 7 – 10 metrics from our text to thrive managing your firm.
1. Total Revenue
When you look at your Income statement, this is the first financial category you will see. For each business, not just law firm, sales are crucial for business success. Sales are the ultimate necessity: sales for a business are like fresh air, water, and food for people.
However, total revenue does not show us the whole picture. If a law firm generates 10 million $ in sales annually, we cannot say much about it, whether it is successful or not. We need to dive into the data and see what the story of this law firm is. The same applies to all professional firms, not just law firms.
2. YoY Total Revenue Growth Rate
After you look at total revenue, you should see how that compares to the previous year. In other words, you should calculate the growth rate of revenue YoY (Year – Over – Year). YoY Total Revenue Growth Rate is calculated using formula below:
Of course, it is preferable for YoY Total Revenue Growth Rate to be positive. However, as your law firm gets larger and larger, the growth rate will generally decline, since you meet a higher threshold by each year. If you compare growth rates with other law firms, please pay attention to comparing them with law firms of similar revenue size.
3. Revenue Per Client
When you divide Total Revenue by a number of clients you get Revenue Per Client:
Should you have higher or lower Revenue Per Client?
Generally, there is no single answer.
If the number is high, on one hand, it means you are focused on several clients and your law firm can focus to meet their requirements and create a good partnership with them. On the other hand, the high value of Revenue Per Client also means your revenue stream is significantly dependent on several clients: if you lose one or more significant clients, your law firm may face financial problems.
4. Revenue Per Employee
Revenue Per Employee is calculated using the following formula:
This is a good productivity KPI (Key performance indicator). However, you should not be looking to maximize Revenue per Employee in short term. Your law firm does not need only lawyers who will find you new clients and directly provide services to them. You also need to time track whether your lawyers are overburdened with administrative, non-billable work: if that is the case, you should consider employing people who will only cover those activities, even if they do not work billable hours. In that way, your lawyers will be more productive.
5. Fixed Fee Share
Generally, law firms generate two types of revenue:
- Fixed fee: lawyer’s fee which is not directly dependent on the result of his/her work. For example, a lawyer provides monthly legal consulting of six billable hours to a client. The fee always stays the same
- Success fee: lawyer’s fee is directly dependent on the result of his/her work. For example, if an M&A transaction is realized, the lawyer charges a fee which is calculated as a percentage of the transaction value
You should analyze what share of total revenue is generated through a fixed fee:
With this metric, you will see what percentage of total revenue is more stable, since the revenue generated through success fee by its definition cannot be planned easily.
6. Success Fee Share
As it is explained above, the share of total revenue generated through the success fee is calculated as:
7. Time Utilization Rate
Just like a manufacturing company sells produced goods, law firms sell hours of its lawyers. Therefore, it is crucial to maximize billable hours and avoid unpaid work for clients. Time Utilization Rate is the share of total billable hours in total working hours (paid and unpaid):
8. Total Hourly Rate
Since your law firm sells hours of your employees, you should calculate what your average billable rate is. The first option is to calculate Total Hourly Rate:
Although this is a good KPI, please have in mind that total working hours include pro bono hours and working hours spent on administration.
9. Billable Hourly Rate
The second option is to divide revenue with total billable hours:
10. Billable Hours per Employee
Since your law firm sells billable hours, you should see an average number of them per employee (it is preferable to take into account only those employees who can provide billable hours, i.e. you should exclude administration staff):
11. Average Cost Rate
One of the most significant business decisions of each professional service firm is pricing. You should define your fee per hour. In order to make pricing decisions, you should be aware of your costs, i.e. cost per hour:
At the beginning of the text, we said that Revenue is usually the first category you will see in the income statement of your law firm. As you go down the income statement, you will get to EBITDA (Earnings before interest, taxes, depreciation and amortization). It is the measure of your operating profit, calculated when you deduct operating expenses (labor costs, rental expenses, subcontractors’ fees, marketing expenses) except depreciation and amortization from operating revenue.
However, the absolute amount of EBITDA tells you something, but it does not tell you the whole story. If you divide EBITDA by total revenue, you get the EBITDA margin:
Profit margins are suitable for comparison (Year – Over – Year or comparing with the competition).
EBIT (Earnings Before Interest and Taxes) is the operating profit category calculated on the basis of the following formula:
However, the absolute amount of EBIT tells you something, but it does not tell you the whole story.
As well as in the case of EBITDA, it is suitable to calculate EBIT margin, in order to compare it with previous periods and with the competition:
14. Net Profit
Net Profit is usually the final category of the income statement. It is profit that stays to the law firm (or any other professional service firm), after financial expenses and corporate income tax are paid. This profit can be retained in a company, so it can be used to finance operations of your law firm, or it can be paid out as dividends to its owners.
Just like for EBITDA and EBIT, you can calculate the Net Profit margin:
15. Free Cash Flow to Firm
During my Bachelor’s and Master’s degree studies, my professor of Business Strategy used to repeat us the following sentence, originally said by American economist Alfred Rappaport:
‘’ Profit is an opinion. Cash Flow is the fact.’’
It is not always easy to calculate a company’s profit, since accountants need to make certain assumptions and arbitrary decisions in order to calculate. However, cash flow is much easier to calculate.
Free Cash Flow to Firm is cash flow your law firm generates from providing its services and is on the disposal for its owners and lenders. The formula of Free Cash Flow to Firm is:
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