Law Practice Management Asked and Answered Blog

Category: Financial Management

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Sep 30, 2014

Law Firm Capitalization – What is the Proper Level for Partner Capital Accounts

Question:

I am the chair of the finance committee for our firm – 17 attorney firm in Chicago. We have 6 equity partners in the firm. We are in the process of admitting a new equity partner and are reviewing our capital accounts and trying to determine our capital needs. I would appreciate your ideas and thoughts.

Response:

There are two categories of capital – short-term or working capital which is used to fund daily operations and long term capital which is used to pay for capital assets such as furniture and fixtures, computers and other office equipment. I guess I am old school but I believe that short term working capital should be funded as much as possible with partner capital and long term capital funded with bank borrowing or leases. I have more and more clients that are funding working capital with partner capital and have no bank debt at all. I have other clients that finance all working capital with their bank line of credit – these firms could find themselves in dire straits if bank credit should tighten in the future.

The amount of working capital needed by a firm depends upon your practice, billing and collection cycles, whether you do contingency fee work, and whether the firm is growing and adding attorneys and staff. As a rule of thumb I suggest that a firm have three times one month's expenses excluding draws in working capital. This would need to be increased if the firm has lengthy billing and collection cycles, does contingency fee work, and is in a growth mode.

Partner capital contributions are usually made proportionately based on partner earnings or ownership percentages.

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John W. Olmstead, MBA, Ph.D, CMC

Aug 19, 2014

Law Firm Profitability Assessment Tool

Question:

I am the managing partner of a five attorney firm in Fort Worth, Texas. I am new to the managing partner role and am looking for a quick and dirty tool to examine our financial performance. Can you point me to a tool that I can use?

Response:

I have a quick and dirty tool that I call the Law Practice Profitability and Management Checklist and you are welcome to use it. It is not an exhaustive assessment – just a tool that can be used to get started.

Click here to access the Law Practice Management Checklist

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John W. Olmstead, MBA, Ph.D, CMC

 

 

Jun 11, 2014

Law Firm Accounting – Structure of General Ledger Chart of Accounts

Question:

I am the newly elected managing partner of a twelve attorney business transactional firm in St. Louis. The firm is trying to implement a more disciplined approach to financial management. I have been charged with developing our first budget and I am having difficulties due to the overall structure of our general ledger. Our system was setup by our outside accountant and the expense accounts lump too many expenses into too few categories. Do you have any suggestions?

Response:

This is a typical problem that I see in many firms. Accountants often setup law firm accounting systems to facilitate preparation of income tax returns as opposed to systems designed to facilitate internal management accounting, budgeting, etc. Often too many expenses are lumped into single categories or are not assigned to categories based up cost behavior. The attached sample general ledger chart of accounts has been a standard recommended for use in law firms for many years by law firm management consultants, the Association of Legal Administrators, and others. Click here for a sample general ledger chart of accounts

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John W. Olmstead, MBA, Ph.D, CMC

 

May 06, 2014

Law Firm Overhead

Question:

I am the managing partner of an 8 attorney firm in Carbondale, Illinois. Recently I was talking with the managing partner of a firm in the area and we were discussing overhead ratios and we seemed to have different definitions of overhead and I am wondering if we were trying to compare apples to oranges. Can you share your thoughts?

Response:

I consider overhead to be the operating cost required to support the producers in the firm. This is a different statistic than expenses. Typically in a law firm overhead is all expenses except for attorney salaries (associate and partners) and benefits. Often overhead is used is various benchmark surveys. However, when determing net income or profit (the profit pool) expenses would include associate salaries and associate and partner benefits. In a professional corporation where officer salaries are expensed we typically add shareholder salaries back to the net income figure to determine the profit pool for benchmarking purposes.

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John W. Olmstead, MBA, Ph.D, CMC

 

 

Apr 22, 2014

Law Firm Financial Management – Higher Profit – Lower Partner Compensation

Question:

Our firm is a 7 attorney firm in Evansville, Indiana – four partners and three associates. I am one of the partners in the firm. Each month we are provided with a profit and loss statement, a billable hours report, fees received reports broken by lawyer, and accounts receiveable reports by lawyer. In 2014 our fee collections are up significantly over 2013 – our expenses are lower – profits are up – yet the money is not there for partner draws and we are having to draw less than we did in 2013? What do you think is happening?

Response:

A couple of reports that are missing from your list - a balance sheet and a statement of cash flows. Even if you are on cash-based accounting not all cash disbursements flow through the profit and loss statement which is the report that reports profit/loss. For the following types of cash disbursements flow through the balance sheet and are not considered expenses:

So while the profit and loss statement may be showing a higher level of profit there could have been other uses of cash that are not reflected on the profit and loss statement. Take a look at the balance sheet and the statement of cash flows reports.

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John W. Olmstead, MBA, Ph.D, CMC

Mar 11, 2014

Law Firm Billing Arrangements – Flat Fees

Question:

I am the managing owner of a four attorney estate planning firm in Phoenix. We also have two paralegals, a receptionist, and an office manager. We have always billed our clients by the hour but have been considering switching to a flat rate billing arrangement. I would appreciate your thoughts and suggestions.

Response:

I am currently working with quite a few estate planning/elder law firms. The majority of these firms are still using "time bill" billing arrangements. (8 out of 10 firms) A few firms are using flat fee arrangements for estate planning and asset protection matters and "time bill" arrangements for estate administration and other matters.

Few firms that are using flat fee arrangements are realizing effective billing rates even close to their standard "time bill" rates. In some cases I have found effective rates per hour $100 per hour less than their standard "time bill" rates. In some cases the problem is not working effectively or efficiently. In other cases the flat fee price has not been properly set or limits placed on the work that will be done for the flat fee – for example – number or document rewrites, etc. 

I believe that more than ever clients are wanting the budgetary certainty that flat fees provide.  I think that a flat fee pricing strategy is a good strategy but the scope of work and proper price point must be properly established. A couple of suggestions:

  1. Do some basic market research – secret shopping – and obtain the best information that you can on competitor pricing.
  2. Review time charges on typical estate planning matters and get a handle on the amount of time that it typically takes – by each office professional – for matters of varying levels of complexity.
  3. Based on these time estimates determine flat fees using the desired standard hourly rate and then add a risk premium of 10%. If a matters typically takes 10 hours and your desired rate is $200 per hour – set the flat rate fee at $2200.00.
  4. Incorporate into your engagement letters, fee agreements, etc.
  5. Get at least 1/2 of the fee before commencing work and the other half before deliveringand executing the final documents.
  6. Keep time sheets on the matters for time expended.
  7. Review at least quarterly effective rates realized on completed flat rate matters.
  8. If effective rates are below your target rate review the time detail and determine where the problem lies.
  9. Make changes and adjustments if needed.

I believe that properly implemented and managed flat fees can be a worthwhile strategy.

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John W. Olmstead, MBA, Ph.D, CMC

 

Jan 28, 2014

Law Firm Partner Compensation – Separate Silos – Profit Sharing

Question:

Our firm is a 9 attorney firm in Orlando, Florida. We have three equity partners and six associates. Currently partners are compensated in accordance with their ownership interest percentages which are 35%, 35%, and 30% respectively for the newest partner. There is growing discontent with this arrangement. We have already evaluated several alternative approaches to compensation and do not believe that they would work for us. Two of the partners share common goals for the firm, have compatible practices and clients, and use almost all of the associate attorney's time and other firm resources. The other partner has a transactional practice (the other two of us are litigators) and operates more as a lone ranger and a separate silo. We are considering creating two profit pies for each of these two silos. I would appreciate your thoughts concerning such an approach.

Response:

I don't run into this approach as much as I did 30+ years ago. In essence this is the profit (or silo) approach to partner compensation. This approach is typically found in firms that believe that the cost of production and consumption of firm resources are disproportionate. Usually there is strong competition in these firms. Small personal injury plaintiff firms are sometimes structured in this fashion.

Using the separate silo (profit center) approach fees and costs (overhead) are allocated to each partner (or partner group or silo) profit center and profit determined for each profit center resulting in separate compensation pies for each profit center. Then each partner draws his or her profit center pie or participates in a sharing arrangement with other partners that are members of the profit center in accordance with an agreement of other partners in the profit center or silo.

The devil lies in the details and the trick is to develop a fair and balanced allocation formula that can be used to allocate fee revenues and costs to the silo or profit center.

Silo, lone ranger, or pure profit center approaches usually results in separate firms operating with a firm (a confederation), each sharing overhead in various proportions. Such firms are usually divisive and the form of organization does not encourage specialization or sharing of work. More often than not there are frequent disagreements over fee and overhead allocations.

Often this approach is the next stop to separate firms – separate books – space sharing arrangement.

Thirty years ago I worked in such a firm – the firm is no longer in business.

So proceed with caution – develop written allocation guidelines and test run the numbers before jumping off the cliff.

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John W. Olmstead, MBA, Ph.D, CMC

 

 

Nov 05, 2013

Law Firm Personal Injury Firm – Key Metrics and Dashboards

Question:

I am the managing partner of a 6 attorney personal injury plaintiff firm in San DIego. We are a high volume/small case firm that depends heavily on advertising. We have 1200 open files and are currently are spending 17% of our revenue on advertising. While our case management system provides us with numerous reports – what are key reports that we should be using?

Response:

Many of the billing and case management systems do a poor job of providing key metrics and dashboards that can be used to manage and control actual operations going forward. In a firm such as yours it is critical that you actively manage your inventory of cases, your pipeline, manage workflow, and insure that you are obtaining adequate return on your marketing investment. Here are a few thoughts:

  1. Think about what you need to know to manage your operations.
  2. What summary metrics (10 or less) should be on your dashboard and will serve as indicators as to whether you are on course?
  3. Use a spreadsheet to develop a dashboard report of these key metrics that are extracted from your accounting and case management systems. Include charts and graphs.
  4. Assign someone the responsibility for preparing the report on at least a monthly basis on the same day of the month.
  5. Use the report as control tool, investigate problem areas, and take corrective action in real time.

Click here for sample dashboard

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John W. Olmstead, MBA, Ph.D, CMC

 

Aug 27, 2013

Benchmark for Law Firm Revenue

Question:

I have recently been hired as our firm's first firm administrator. We are an insurance defense firm with 14 attorneys located in Memphis. This is my first law firm. Previously I managed a mid-size CPA firm in the area. I am interested in your thoughts concerning law firm revenue benchmarks.

Response:

Surveys vary. However, national averages for all firm – types – sizes, etc. tend to be around $385,000 per lawyer. I have firms averaging $250,000 to $550,000 and up. So it varies by location, type of practice, size of firm, etc. However, I believe that $300,000 per year per lawyer should be considered a realistic goal for all firms, all sizes, all practice areas, and all locations. For some firm this might be a stretch – but I believe it to be an attainable goal.

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John W. Olmstead, MBA, Ph.D, CMC

Jul 30, 2013

Impact Of Law Firm Growth Upon Management and Organizational Structure

Question:

Our firm is a five attorney firm in Peoria, Illinois – three partners and two associates with four staff members. One of our legal assistants wears two hats – she serves as our office manager and also performs legal assistant duties for clients. Three years ago we had two attorneys and two staff members. We are feeling the consequences of our growth – our caseload has increased by 200%, our overhead is much higher and even though we have greater revenues – our take home earnings is less. We are overwhelmed. I would appreciate your thoughts?

Response:

It sounds like your firm has outgrown your management (organizational) structure. A firm with nine people is a different firm than a firm with four people. You are at a difficult size – large enough to feel the pains and challenges of being larger than two attorneys and two staff members but not large enough to reap the organizational benefits of a larger firm such as a full-time firm administrator, accounting manager, HR manager, etc. (I believe that as a law firm grows – management gets harder until a firm gets to around 12 attorneys – then as the firm begins to put in place a management team – it gets easier.)

In the meantime you might want to consider the following:

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John W. Olmstead, MBA, Ph.D, CMC

 

 

 

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