Question:
Our firm is an 8 attorney general practice firm in Kansas City. In addition to hourly work we have a heavy mix of contingency fee work as well. Other than our monthly profit and loss statement and a report of hours produced we have no other financial reports that we use. I have read about financial dashboards. What might we use them for in our firm?
Response:
In these economic times effective pipeline management is becoming more and more important in law firms – especially in those firms that do a lot of contingency fee work. This might be a good place to start using some dashboard metrics.
Pipeline management is a term used in the management consulting profession to refer to the process by which you continually evaluate your active opportunities (prospective clients to booked clients) for their balance of QUALITY and QUANTITY. The goal is to continually stay on top of the overall health which is a full pipeline. Pipeline management allows client relationship managers to more accurately forecast fee revenues, better staff and manage client engagements, and close more client business.
I often also refer to Pipeline Management in law firms in the context of using financial dashboards by which the individual charged with financial management responsibilities is continuously aware of significant changes in the firm's Pipeline (from prospects to cash):
By comparing these dashboard statistics to a prior month, quarter, or year – you are able to measure the effectiveness of your marketing and avoid financial surprises down the road.
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John W. Olmstead, MBA, Ph.D, CMC
Question:
Our firm was started 20 years ago by four partners. We how have the original four partners as well as six associate attorneys. Originally each of the four partners contributed $25,000 each to their capital accounts. We are considering extending partnership to a couple of the associates. We have talked with other law firms and some require buy-ins (capital contributions) and others do not. What are your thoughts?
Response:
My first question is whether you are planning on creating a non-equity partnership tier. If so, then the associates would initially be brought into that tier first.
Typically a buy-in or capital contribution is not required for non-equity partners nor do I recommend such. Typically non-equity partners are salaried and may participate in some form of an incentive bonus system tied to individual, team, or firm financial performance. They are also not required to assume any responsibility for any of the firm's financial liabilities or debts.
If you intend on bringing in the associates as equity partners that is another matter. I believe that all new partners should be expected to contribute capital and have some "skin in the game." Whenever a firm admits a new partner, the firm should require the new partner to contribute capital. Increasingly, a partner's capital requirement should bear a relationship to the partner's share of profits. You may want to allow new partners a reasonable period of time to fund their capital accounts – say five years or help them arrange favorable terms at your bank to finance their capital accounts.
Some firms have a buy-in tied to either the cash-based book value of the firm or the accrual-based book value (includes accounts receivable and work in process). This is not the typical practice although I do run into it. Usually capital accounts are tied to working capital needed to operate the firm and the percentage of ownership/income that each partner will have.
There are only three ways to increase a firm's working capital to cover cash flow requirements and fund growth:
1. Have partners put more money in
2. Have partners take less money out
3. Borrow
Many firms use bank credit lines instead of capital contributions to pay routine firm expenses and partner draws during periods when cash flow is tight. It has been my experience that firms that follow this practice have ongoing financial challenges and problems.
The reality is that many firms are under-capitalized – don't become one of them!
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John W. Olmstead, MBA, Ph.D, CMC
Question:
Our firm has been struggling for the past couple years. We have lost three key institutional clients, had partner defections to other law firm, and have suffered financially. We were a 40 attorney firm- six years later we are ten. We simply must improve profitability. What areas of our overhead should we attack first?
Response:
Many law firms waste considerable time trying to find ways to cut a pie that is too small up differently by implementation of new compensation systems or increasing the size of the pie by decreasing costs. While unnecessary expenses should be reduced – once they are reduced a repeated effort to slash costs proves fruitless as a strategy to increase the firm pie. The vast majority of law firm expenses are fixed or production-related. The percentage of costs that are discretionary is low, typically in the 20-30 percent range, and the number of dollars available for savings is small. The available dollars available for reduction disappear after a year or two of cost-cutting, leaving the firm with dealing with the effects of further cuts on production capacity. For example:
§ Should a firm eliminate staff positions if the result is additional administrative burden on lawyers and paralegals thereby reducing the revenue capacity of the firm.
§ Should the firm cut lawyers continuing legal education if improving an attorney's level of expertise is important to increasing revenue production.
§ Should a firm cut the marketing budget?
Once a firm has eliminated wasteful spending and made appropriate adjustments to the budget, further cost reductions often results in the firm reducing the possibility of turning the firm around, improving financial performance, and increasing the pie.
Increasing revenue, while maintaining the same expense structure, is the most powerful approach to improving firm profitability. Additional revenue goes directly to the bottom line and makes a significant impact on partner profits. If the firm is able to increase revenue by10% while maintaining the same cost structure, 100 percent of the additional revenue dollars will go to the partners.
So think revenue – not costs!
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John W. Olmstead, MBA, Ph.D, CMC
Question:
Our firm, a 12 attorney firm in Detroit, needs to find a way to improve fee revenues and financial performance in 2012. We do not have a business or strategic plan, have never had a retreat, and we don't even have a budget. We believe that we must do something for 2012 and yet we are out of time since 2012 begins next week. Any suggestions?
Response:
Generating adequate fee revenue is the primary challenge for most law firms and this is where I would start for 2012.
I am a strong believer in the power of focused goals and objectives when integrated with a system of accountability. I have clients that have improved fee revenue by 20% (over a two-three year period) with existing headcount simply by establishing production goals for each attorney and paralegal in the firm – reporting, measuring and reporting goal v.s. performance monthly using simple reports, and follow-up with individuals behind on their goal attainment. Solo practitioners can use the same system and use a staff member, spouse, or coach to serve as an accountability partner. You might want to consider the following:
Try to get this in place by January 1, 2012 and see how this works for you and consider this your first baby step. Down the road you might want to consider a firm budget and eventually a strategic plan. See Helen Gunnarsson's article on strategic planning in the November issue of the Illinois Bar Journal.
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John W. Olmstead, MBA, Ph.D, CMC
Question:
I am a partner in a 14 attorney firm. Our bookkeeper has been with us for 20 years. We have a time and billing system, a separate bookkeeping system, and a separate database for clients, and something else for trust accounting. The other partners and myself do not know the name of the software that we are using, don't know how to access the software, and we have to ask the bookkeeper for any financial information that we require. We feel like "hostages". She gets offended when we ask questions. When we do receive information we don't know how to read or interpret much of the information. How can we get control of our firm back?
Response:
It is imperative that owners and partners in a law firm have access to financial information on a timely basis, understand the information, and use the information in a proactive way to manage the practice. We suggest:
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John W. Olmstead, MBA, Ph.D, CMC
Question:
As the administrator of our 17 attorney law firm I am charged with the responsbility of managing and controlling costs. Our management committee is always complaining about our overhead – – and then looking to me for solutions – with the focus usually on cost reduction. Do you have any recommendations?
Response:
I am often asked to help law firms design and implement profitability improvement programs. In most of my engagements the real problem is insufficient gross income and lack of sufficient investment (spending and time) on marketing and initiatives designed to stimulate client and revenue growth. For most firms increasing revenues is the most effective way of impacting the bottom line. However, we do find that there is waste and unnecessary overhead that eats away at profits and a cost control program is also recommended and implemented. During recessionary times such as we are currently facing – drastic cost control are often the only option. Reducing overhead can immediately and effectively improve a firm’s bottom line.
The first step in an expense control program is to identify those areas where potential savings exist. Review your profit and loss statement. Resist the temptation to arbitrarily cutting costs which could cut the muscle with the fat and result in revenue loss as well. You have to spend money to make money – so if cost cutting is the appropriate strategy – cut the right costs. Think strategically about cost reduction.
After you have identified areas where savings can be made prioritize and develop specific strategies and implement action plans to achieve the savings.
Here are a few ideas:
STRATEGY #1: Reduce Headcount
This is the largest area for potential savings. Downsizing is a strategy that has been used by many firms this past year. However, it can have long term negative consequences for revenue and talent management. Consider all levels – non-productive partners, associates, paralegals, and staff. Be prudent and sensitive in implementation.
STRATEGY #2: Reduce Compensation
Obviously one way is to cut salaries – a strategy to be used as a last resort. A better approach is to reduce fixed salary (paying people for showing up) and add a variable pay component which will allow employees to earn additional compensation in the form of bonus for results achieved. Another approach is to freeze salary increases.
STRATEGY #3: Benefits
A major area for cost savings – especially health insurance. Determine which programs are most important to employees. Do your best to protect those and reduce or eliminate programs that are less important. Consider offering more than one health insurance plan. Pay the premium for the lowest cost plan and provide options for employees to “opt up” to the better plans by paying the additional premiums. Consider increasing deductibles and requiring employees to pay a portion of the base premiums.
STRATEGY #4: Outsource
Examine potential for outsourcing – from copy services – IT management – to your legal team.
STRATEGY #5: Occupancy
Review your lease invoices and question increases and escalators for which you have been charged. Consider renegotiating your lease and ask for a lower rate. Reduce excess space either through a renegotiated lease or through sub-leasing.
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John W. Olmstead, MBA, Ph.D, CMC
Question:
Our five lawyer firm has had a very successful past couple of years. We have been growing in terms of clients, billings and revenues. However, we are getting deeper into our credit line and we simply don't have adequate cash to pay our bills. I would appreciate your thoughts on this matter.
Response:
Sounds like you are caught in the growth-cash flow trap. Growth puts strain on cash and increases demand for additional working capital. There have been many law firms and small businesses that were profitable – but failed due to simply running out of cash. While you cannot escape this paradox – by actively managing your cash flow (timing of the intake of cash against the outflow of expenses) you can minimize the impact of the following traps:
Law Firms often experience these top cash flow problems when they do not manage the store and practively manage their income, receivables, and payables. Many are left wondering how they went out of business while their clients and revenues were growing substantially.
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John W. Olmstead, MBA, Ph.D, CMC
Question:
Our firm does mostly flat fee work. I am the sole owner of the firm and am considering hiring my first associate. Each of us work as a team and do a lot of cross-over work on all client/matters. I have two paralegals. We don't keep timesheets on our flat fee cases. Do you have any suggestions as to how to proceed with the hiring of this associate?
Response:
It sounds like your firm is relucantly approaching the next step in its growth. Adding your first associate will change the dynamics of your firm and will require you begin to implement more formal approaches to performance management for all members of your team – the new associate, your staff, and yourself. I would start by thinking through the exact tasks and roles that you would like the associate and other staff members to perform. In other words define the associate position. Do to expect the associate to bring in business? Are you willing to train a new associate without experience or are you looking for someone with experience. Can you structure work so there is less crossover of team members on files? If not, how are you going to measure their performance and production? (Time, their production fee dollars, file or case counts, etc.) Are you going to incorporate a variable pay or incentive bonus component into the compensation plan for the associate as well as the other staff members? (More firms are doing this) Define the position first and then decide on the "who".
I encourage you to begin establishing production (performance) goals for all employees and then measure performance against these goals. Tied at least a portion of compensation to accomplishment of these goals. More firms are starting to pay for performance and less for simply showing up.
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John W. Olmstead, MBA, Ph.D, CMC
Question:
At a recent managing partner forum several of the attendees at the seminar discussed recent experiences with embezzlement by employees. What can we do to protect our firms?
Response:
During the past 25 years that I have been working with law firms I have been amazed at the number of embezzlements caused by unscrupulous attorneys, bookkeepers, office managers and other staff members. And yes – even partners. One out of five law firms in my client sample has actually lost funds due to some form of embezzlement and caught the offenders. While some of the firms have prosecuted and taken other actions against the offenders the process was very painful, time consuming, and typically the funds are never recovered in entirety. Of course, this is if you catch the offenders.
Many small firms’ internal control procedures are so lax that funds could be lost through embezzlement and the firm would not even know it.
Only through effective internal accounting and financial controls can law firms protect their offices from theft. The goal is not to catch offenders – but to have a system in place that discourages and prevents the theft from occurring in the first place.
The process involves implementing internal accounting and financial controls. In essence – segregation of duties. Here is an overview of such a system:
Internal Control is the plan of organization and all of the coordinate methods and measures adopted within a business organization to safeguard its assets, check the accuracy and reliability of its accounting data, promote operational efficiency, and encourage adherence to prescribed managerial policies.
The four basic elements considered essential in a satisfactory system of internal control are:
SUGGESTIONS:
RECEIPTS
DISBURSEMENTS
GENERAL
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John W. Olmstead, MBA, Ph.D, CMC
Question:
As the managing partner of a 12 attorney I have been asked to see what the firm can do to improve profitability by reducing costs. Do you have ideas or recommendations in this area?
Response:
In most law firms the real problem is insufficient gross income and lack of sufficient investment (spending and time) on marketing and initiatives designed to stimulate client and revenue growth. For most firms increasing revenues is the most effective way of impacting the bottom line. However, we do find that there is waste and unnecessary overhead that eats away at profits and a cost control program is also recommended and implemented. During recessionary times such as we are currently facing – drastic cost control are often the only option. Reducing overhead can immediately and effectively improve a firm’s bottom line.
The first step in an expense control program is to identify those areas where potential savings exist. Review your profit and loss statement. Resist the temptation to arbitrarily cutting costs which could cut the muscle with the fat and result in revenue loss as well. You have to spend money to make money – so if cost cutting is the appropriate strategy – cut the right costs. Think strategically about cost reduction.
After you have identified areas where savings can be made prioritize and develop specific strategies and implement action plans to achieve the savings.
Here are a few ideas:
STRATEGY #1: Reduce Headcount
This is the largest area for potential savings. Downsizing is a strategy that has been used by many firms this past year. However, it can have long term negative consequences for revenue and talent management. Consider all levels – non-productive partners, associates, paralegals, and staff. Be prudent and sensitive in implementation.
STRATEGY #2: Reduce Compensation
Obviously one way is to cut salaries – a strategy to be used as a last resort. A better approach is to reduce fixed salary (paying people for showing up) and add a variable pay component which will allow employees to earn additional compensation in the form of bonus for results achieved. Another approach is to freeze salary increases.
STRATEGY #3: Benefits
A major area for cost savings – especially health insurance. Determine which programs are most important to employees. Do your best to protect those and reduce or eliminate programs that are less important. Consider offering more than one health insurance plan. Pay the premium for the lowest cost plan and provide options for employees to “opt up” to the better plans by paying the additional premiums. Consider increasing deductibles and requiring employees to pay a portion of the base premiums.
STRATEGY #4: Outsource
Examine potential for outsourcing – from copy services – IT management – to your legal team.
STRATEGY #5: Occupancy
Review your lease invoices and question increases and escalators for which you have been charged. Consider renegotiating your lease and ask for a lower rate. Reduce excess space either through a renegotiated lease or through sub-leasing.
STRATEGY #6: Telephone Service
Scrutinize your bills and examine rate tariffs as well as items that have been tagged to your bill by third parties. Negotiate and ask refunds for any discrepancies or abuse found. We have seen firms receive thousands of dollars in refunds.
STRATEGY #7: Virtual Office
Do you need an office at all. Many solos are working out of virtual and home offices or a combination of same. Some larger firms are reducing the size of their primary expensive downtown offices by having some attorneys work from home offices or other locations.
STRATEGY #8: Marketing
Many firms actually need to spend more money on marketing. However, this does not mean that it should be wasted on sacred cows. Review marketing investments, eliminate feel good items, and insure that they are producing results. Reallocate funds.
STRATEGY #9: Supplies and Other Purchases
Eliminate waste and unnecessary expenses. Consolidate with fewer vendors and solicit discounts for exclusive relationships.
STRATEGY #10: Develop a Budget and Financial Plan
If you don’t have one – develop a budget and financial plan and work the plan.
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John W. Olmstead, MBA, Ph.D, CMC