“This time next year I am going to be a millionaire”

 In Practice Management

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It’s time to try something different

Most firms are fast approaching their year end. As this time of year approaches, hopefully the profits earned are satisfactory and mean that the firm can afford to invest so that it can continue to flourish for years to come. But wouldn’t it be great if next year a far greater profit could be earned without the need to work any harder. Too many firms are trapped in a cycle, where to make more profit, people need to work even harder.

Dig deeper to understand profitability

The annual accounts will reveal the profit earned for the period and show you the margin that is being achieved. The average law firm margin is just over 20% but some firms achieve profit margins in excess of 40% and other firms make losses. If your firm is normal and in aggregate makes a profit of 20%, this does not mean that this is the margin being earned on all files. Indeed, the margin being earned on individual files is likely to vary enormously with some files being unbelievably profitable and other files generating losses. In firms that bother to do this analysis it is not unusual to see that around a third of files are loss making.

Clearly, if the loss-making files can be identified so that we do not take on this type of work in future or if we can look again at how this work is done in future periods, then there could be a significant increase in profits. Equally, if we can understand how we are running certain files to make more profit, then this approach could be used more widely and it might also help us to focus business development activities towards generating more profitable work.

How can I measure file profitability?

The simplest way of looking at matter profitability is to look at the recovery rate achieved, being the percentage of time billed compared to the time recorded. Recovering 100% of time is clearly more profitable than if we are only able to recover 80% of our time. While easily measured, this approach is not ideal because it assumes that there is a constant profit margin across all fee earners which is unlikely to be true. Many firms discount partner rates to make them more attractive to clients and as a consequence the margin being earned by a partner might be lower than for a more junior lawyer.

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It would be better to calculate the real matter profitability by deducting from the fee earned the lawyer cost recorded to the file. In principle the calculation of lawyer cost per hour is straight forward because it is simply the annual cost of the lawyer divided by the number of chargeable hours recorded in the year. The calculation can be further refined by taking the cost each month of the lawyer and dividing that by the hours recorded in that month. By using this approach, the cost per hour of the lawyer will be lower in months where the lawyer is busy and higher in the months where the lawyer is utilised less. And how can we allocate the cost of a partner to a file? A notional salary can be used, and this notional salary should be higher than for any other fee earner.

Once cost has been allocated to files in this way, it is then possible to analyse all the matters by size, by client, by work type and by partner and in so doing you can better focus your attention on the files, clients and fee earners where some change is needed if profits are going to grow substantially.

Undertaking this kind of analysis takes some time the first time but the benefits of it will be great and when the process is repeated on a regular basis you will find that the time taken for the analysis becomes less significant.

Gill Steel

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