Olmstead & Associates Law Practice Management Asked and Answered Blog

Law Firm Profit Improvement Strategy

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

Goals and Plans For Focusing the Law Firm in 2012 and Beyond

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:

1. Ask each attorney and paralegal to provide SMART (specific, measurable, attainable, realistic, and on a timeline - i.e 2012) goals for fee generation, fee origination, billable hours, etc.
2. Review and discuss these goals with each member and engineer an agreement (commitment). Insure that there is adequate stretch - but that the goals are attainable.
3. Setup a monthly report, spreadsheet if necessary, listing each individual and including their monthly goal number(s), actual performance, variance, year to date goal number(s), actual performance and variance.
4. Review and discuss monthly at firm meeting, management committee meeting, or whatever forum is appropriate for your firm.
5. Follow-up and meet with individuals that are falling behind. Devise strategies for improving performance or revise goals if unrealistic.
6. If the firm has insufficient client work use this as a tool to bring out into the open and create specific business development initiatives to deal with such issues.
7. Find ways to tie attainment of goals to compensation.

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

Getting Control of the Financial Side of Law Firm Practice

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:

1. The owner, or an appointed partner(s) in larger firms, obtain a basic level of understanding in basic accounting/bookkeeping and law firm financial management.
2. The owner, or an appointed partner(s) in larger firms, obtain detailed training on the accounting software system(s) along-side the bookkeeper when the system is implemented. In addition to general operation of the software, special training should also be obtained on interpretation and use of the management reports.
3. In your current situation - this may be a good time to consider upgrading your system and at that time obtain training on the new system, review the roles of all parties, and current procedures.
4. Insure that you have accounting controls in place and appropriate segregation of accounting duties.
5. Outline your expectations and requirements of the bookkeeper, meet with her/him, and communicate appropriately.
   

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

Controlling Cost and Managing Overhead in the Law Firm

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.

Click here for our blog on financial management

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

 

Managing Law Firm Cash Flow

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:

1. Lack of Attention Paid to Financial Management. Many law firms, especially solos, often give this task a low priority on their to do list. Servicing clients and new client development are given higher priorities. There is often a lack of understanding of financial reports and statements. Understanding financial reports such as income statements v.s. cash flow statements are important is providing early detection of potential cash problems requiring corrective actions. Law firms should develop reasonable monthly, quarterly, and annual cash flow projections as well as income and expense projections.
2. Poorly Managed Accounts Receivable. Cash is king. Law firms need to improve client payment terms and cash collections by speeding up billing cycle, getting more upfront through initial retainers, requiring retainer replenishments, and staying on top of retainers. Use your billing software reports to review retainer useage weekly, if not daily. Billing and accounting software should be implement any potential delinquent accounts and someone in the firm, or outside of the firm, should be responsible for prompt follow-up to collect all outstanding invoices. Depending on the resources available, a law firm may decide to out-source accounts receivable management and collections to industry professionals and specialists.
3. Heavy Investment in Client Advances. Many law firms have large investments in client advances. For firms that book these expenditures as an asset - these items will not be reflected on an income statement as expenses. Be aware of their impact upon cash flow and look for ways have the client pay these directly, and bill sooner with cost only out-of-cycle invoices. Contingency fee firms will have to cover with additional working capital or line of credit.
4. Paying Invoices too Quickly. Another way of improving cash flow is to slow down the outflow of cash by insuring that payables are not paid until they are due. I find many firms simply pay invoices when the invoice comes in the door - way before they are due. Monitor payment terms and pay when due.

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

 

Increasing Law Firm Profitability: Using Metrics and Measurements to Focus Performance

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

How Can Protect My Law Firm From Embezzlement?

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:

1. A plan of organization that provides appropriate segregation of functional responsibility and duties.
2.  A system of authorization and record procedures adequate to provide reasonable accounting control over assets, liabilities, revenues, and expenses. 
3. Sound practices to be followed in performance of duties and functions of each of the organizational areas. 
4. A degree of quality of personnel (competency) commensurate with responsibilities.

SUGGESTIONS:

 RECEIPTS

1.  Have someone other than the bookkeeper open the mail. (i.e. receptionist) 
2. Have the person who opens the mail prepare a list of all checks/cash received in duplicate. 
3. Have person responsible for mail route one copy of the check/cash list to the office manager or managing partner and the other copy along with checks/cash to person responsible for making the bank deposit. 
4. Assign someone responsibility for preparing the deposit and taking it to the bank. This person should verify the check/cash list against checks and cash, prepare deposit slip and make the bank deposit. 
5. Upon return from the bank the deposit clerk should provide the bookkeeper with the deposit slip, receipt from the bank, and the check/cash list. 
6. Bookkeeper enters the deposit into the computer system. 
7. Office manager runs and mails monthly statements - not invoice fee bills - to clients.

DISBURSEMENTS

1.  Don't give bookkeeper check signing authority.
2.  Have someone other than bookkeeper approve vendor invoices. Require evidence of approval on all invoices. 
3. Require purchases to be handled by someone other than the bookkeeper and the individual who approves vendor invoices for payment.

 GENERAL

1.  Obtain adequate fidelity bonding insurance coverage. 
2. Rotate duties when possible. 
3. Have bank statements mailed to managing partner's home. He/she should bank statements and transactions and then give to someone other than bookkeeper and other personnel involved in processing receipts or disbursements. Some firms have their outside accounting firm perform this function. 
4. Reconcile all bank accounts monthly. 
5. Insure that adequate record retention systems are in place. 
6. Formulate policies that provide for reasonable protection of assets. 
7. Insure that adequate personnel selection methods, training programs,  supervision practices, and performance evaluation techniques conducive to control, providing assurance than an adequate number of employees are available to perform operational duties. 
8. Insure that vacations are mandatory and contain provisions for competent replacements to perform all of the assigned duties of the vacationing employees. 
9. Outline job duties in written job descriptions.  
10. Develop an accounting manual. 
11. Properly supervise, verify, and follow-up on all operations, people, and systems.

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

 

 

 

Improving Law Firm Profitability Through Cost Reduction

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

 

 

Contingency Fee Profitability: Can You Make Money From Contingency Fee Work

Question:

Our firm is a 12 attorney general practice firm located in the Phoenix metropolitan area. In additional to general practice, we do a fair amount of insurance defense work as well. In an effort to improve firm profitability we have been considering alternative fee arrangements - particularlly contingency fees - with some of our existing clients as well as venturing into personal injury plaintiff work. Can we improve profitability by doing more contingency fee work?

Response:

The CEO of the Howrey LLP, when interviewed about the law firm's recent dissolution, advised that deferred profits from contingency fee work led to the firm's demise.  Howrey is a good illustration of what can happen when the risks of contingency fee work is not considered or managed. Contingency-fee work can pose major risks for law firms, as they earn no fees if they lose those cases and sometimes have profits deferred in protracted litigation. In addtion, cases can be lost with no fee whatsoever recevied. Whether your firm is considering "big deal" litigation or bread and butter run of the mill personal injury litigation you may want to consider the following:

1. Don't dabble in contingency fee work. Take it seriously and insure that your case portfolio is adequately diversified.
2. Reduce case portfolio risk and improve case profitability by implementing a sound case intake system to insure that you are selecting quality cases.
3. Realize that you have to spend money to make money and that you simply may not have the financial resources to take on certain cases. Learn how to say no and when to refer these cases out to others.
4. Insure that you have an adequate portfolio of cases (number of cases, size and type) to insure diversification and manage risk.
5. Analyze the profitability and return on each case and ascertain what can be done differently on future cases. Typical metrics include effective rate and/or LODESTAR.

In essence the fundamentals of risk and return is at work and should be considered when accepting contingency fee work. You are betting that you can beat your hourly rate that you receive (or would receive) on hourly work. Contingency fee work often involves the risk of no fee at all, financing the case, long time periods before the case is concluded and fees are received, client advance investments, etc. For these risks the firm should be able to expect a premium. In other words - the effective rate on contingency fee cases should (on average) be greater than that for hourly work.

Many law firms are not receiving a "risk premium" at all and are often, on average, obtaining an effective rate close to their bill rate. So, do consider the risk involved and evaluate methods of mitigating the risk as much as possible. In general - don't dabble - but work to a portfolio of cases large enough to diverisfy your risks.

Herbert Kritzer has done extensive academic research over the years on contingency fees which can be found in his book - Risks, Reputations, and Rewards: Contingency Fee Legal Practice in the United States. The book can be ordered from Amazon.com. Link to Amazon

While I have outlined a cautious approach here I want to also clarify that I have many clients that are doing very well and making a lot of money doing contingency fee work. It is the firms that did not grow up doing contingency fee work that "dabble" where I see the problems.

So proceed with caution - but go for it if it makes strategic sense for your firm.

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

Law Firm Financial Statements

Question:

I was just elected by my other partners to serve as managing partner of our 17 attorney firm. We are based in Nashville, Tennessee. I do not have an accounting background and I have questions about our financial statements:

1. Why does the income statement not reflect all disbursements for the month? For example it does not reflect partner draws, client advances, or payments on the firm line of credit?
2. I have only been receiving the income statement. Should I been receiving other financial statements?

Response:

Getting a handle on the financial aspects of your firm will be your most important role - whether you have a firm administrator or not.

You should also be receiving a balance sheet which reflects the firm's financial position as of a particular point in time. The income statement only reflects income and expense accounts and reports net income for a reported period of time. The income statement is different that a statement of cash flows which reports cash flows during the period. Partner draws, client advances, and line of credit payments are not expense accounts (they are asset, liability, and capital accounts respectively).  Consequently, they will not be reported on the income statement. These accounts will be reported on the balance sheet.

Other than reviewing the balance sheet for activity in accounts such as discussed above the balance sheet (without adjustment) has limited use. It's purpose is to reflect the firm's financial position as of a point in time. However, since most law firms maintain their books on a cash basis - the largest assets - accounts receivable and unbilled work in process - are not reflected. Accounts payable and other such liabilities are not reflected either. If you are interested in a true picture of the firm's financial position as of a point in time you must take these items into consideration.

Another report that you may wish to receive is a statement of cash flows. This statement will report actual flows of all cash - in and out of the firm - regardless of account time.

There are additional schedules and reports that you should receive as well. Suggest you review your system and create a report distribution policy as to which reports you and the other partners receive each month.

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