January 2015 | Peggy Gruenke | Clio and Law Practice Management Consultant
Law firms are profitable businesses
Let’s set the stage with a very positive image: Law firm business models are very profitable models. According to a Fortune magazine article, in 2014, law firms ranked second as a profitable business model with an average profit margin on 17.8%. So, yes, you can make money running a solo law firm! That doesn’t mean it’s easy to do but with the right tools in place at least you will now if you are being profitable.
So it’s January and you will be sitting down to reconcile your bank accounts for December’s activity and looking at your year revenue and expenses. This is an exercise you do (should be doing) every month. As long as there’s money in the checking account, life must be good – right? Maybe, but it begs the question, “Was your business profitable in 2014 and can it be doing better?”
January is a good time to step back and review the financial health of your solo or small firm business. While there are many areas to look at as you prepare for 2015, this article will discuss two areas:
- Reports you should have in place and reviewing at the end of the year and monthly to help you better understand the financials of your firm.
- Key metrics should you be reviewing to reveal weaknesses in your business. Or identify strengths and give yourself a pat on the back.
Preparing for 2015: Reports for reviewing Money In, Money Out
Money Out: Review your budget tracking worksheet which has been tracking expenses by month: actual vs. budget. This report provides a birds’ eye view of how you spent money in 2014 and compares it to your budget. For 2015, it will be your data for creating your 2015 budget.
The key thing to look at on this report:
- Where did you overspend? Maybe the extra expenditures are justified.
- What accounts never had expenses applied to them? This would be for 2 reasons:
- Maybe you created expense categories but never used them. If so, remove these accounts so the report is less cluttered and easier to read
- Maybe you have expenses allocated to the wrong accounts. You will want to fix this so you have a true picture of actual expenses.
Added bonus: If you are not currently using accounting software, this worksheet can be setup to reflect the proper way to organize your chart of accounts for that accounting system. The chart of accounts is simply a way to categorize firm expenses and income.
Review your cash flow worksheet. You can’t make smart decisions without all the information, and yet a surprising number of attorneys have no idea what the firm’s financial situation is. In a small or solo firm, attorneys, for the most part, handle their own billing so it is even more important to have a clear and simple view of the practice’s finances. How much do you have to bill each month and what is your collection rate?
This worksheet combines your revenue and expenses into one financial dashboard report. The way I have it setup includes the budget, monthly actual amounts, and budget vs. actual for revenue and expenses. During the year, this report will keep an eye on the bank accounts, your monthly “nut”, revenue and expenses, by month. During the year, this report provides you with data to make decisions about your business so you can be proactive and not reactive. At the end of the end of the year, it is a great summary of your business.
What is your monthly “nut? It is the money you need to collect every month to pay fixed expenses for the firm. You can include your own salary in this monthly “nut” number or you can keep it separate. If you keep it separate, you know that money collected above this amount is a paycheck for you. Know this number and keep it written down some place where you will see it every day. I actually recommend solo lawyers build their monthly paycheck into the monthly “nut” number. I believe it makes you think of paying yourself every month and staying on top of billing and collections.
QUESTION: Does your budgeted income number reflect your collection realization rate? If you budget to bill 1500 hours/year at $200/hour, your budgeted revenue is $300,000. But it’s not a perfect world and this is not what will be collected. Knowing your collection realization rates will help you set a realistic revenue number to drive your budget. (See measuring key metrics below.)
Flat Fee Cases: If you do flat fee cases, do you know how profitable you are on these cases? This is a good time to review the profitability of your flat fee cases in 2014. The New Year provides you a wonderful chance to raise your rates. If you have not been tracking this information, you may now see why this is important to track.
In part 2 of this article we will look at six key metrics you should be tracking. If not six, pick three. You have to be able to measure progress and you can’t do that without collecting good data.
I am owner of LegalBizSuccess, a company whose mission is to help solo and small-firm lawyers build better businesses. I am active in the ABA GPSolo Division, where I head up the technology committee and am vice-chair of the national conference committee. Follow me on Twitter @PeggyGruenke.