Knowing how to determine what factors have the most impact on your financial health requires a solid law firm profitability analysis strategy. The invaluable insights this process produces will ensure that every ounce of your energy is helping you maximize your firm’s profits.
But, remember: realization and profitability are not the same. Your law firm could be achieving outstanding results in billing and/or collection efforts, but this is just one part of a bigger picture. You could still be hemorrhaging crucial budget dollars despite not having any write-downs. This makes having a comprehensive software solution for your legal office a must when trying to get a clear picture of different KPIs impacting your bottom line.
Are you conducting your law firm profitability analysis the right way?
While many firms prioritize their profitability efforts, some perform their analysis using outdated methods or without complete or accurate data. This is often highlighted by law practices primarily relying on metrics surrounding their revenue vs. expenses numbers. It means that a balance sheet that isn’t in the red doesn’t necessarily indicate your firm is at its maximum potential for profit.
You need an analysis that considers all of your most important KPIs so you can develop a true picture of your current financial performance in all areas of the business that matter most.
As you add new clients, hire additional attorneys, and try to keep track of billable hours in the process, gathering all this data in one place can be time-consuming without the right technological tools to help. Thus, a centralized approach to managing all this information is the only way to truly conduct an accurate profitability analysis.
Metrics to measure when analyzing your law firm’s profitability
Taking a systematic approach to your profitability tracking efforts can help you stay ahead of future financial challenges. But to get the most out of your revenue, it’s critical to know which metrics your firm needs to be measuring in the first place. Being able to drill down to the core aspects of your costs and revenue requires close attention to not just the practice area but the profitability of your partnering attorneys, as well as hours spent.
Here are some law firm profitability metrics that you will find especially helpful to include in an overall analysis of your law practice’s ability to maximize its revenue:
Your billing rate can fluctuate at times depending on the type of legal work you perform for your clients. Sometimes, you may even opt to discount your services, which can affect your overall realization rate.
For example, if your standard hourly rate is $200 per hour, and you work 120 billable hours in the past month, your billable hours should total $24,000. But, maybe you opted to discount your services for a family member needing your assistance and only charged them $100 per hour for their 30 billable hours. As a result, you only receive $3,000 instead of $6,000. This drops the value of your billed hours down to $21,000.
Your billing realization rate for the month would be at 87.5% (actual billed amount divided by value of time worked at the standard rate).
Another important KPI to determine how much success your law firm is achieving is its utilization rate. This reasonably straightforward measurement tracks your worked hours and divides them by the hours you billed out.
For example, if your average billable rate is $275 per hour, and you worked a full 40 hours that is 100% billable, you would generate $11,000 in revenue for your practice. But, utilization of those hours is rarely 100% and that can impact your rate.
Should you work a 40-hour week but spend 20% of that time (8 hours) on non-billable tasks like traveling depositions or court hearings, handling phone calls, or other duties, your revenue is actually going to be $8,800. That’s a $2,200 difference! Discovering inefficiencies like this can help you better prioritize how you perform your billable work and possibly re-evaluate what tasks are included in your rate.
When determining how much of your revenue is collected annually, you are generating your collection rate. This typically involves taking your total collected revenue and dividing that number by the total billed to clients. Doing this helps you understand how efficiently you turn billings into cash.
An example would be receiving $15,000 in payments from your clients last month, but you sent out $21,000 in billings. This means your collection realization is only at 71% (revenue received divided by revenue billed), which could be a warning sign that you need to evaluate your fee structure, billing options, collection methods, and other processes that directly affect your clients’ ability to pay. Sometimes, simply adding an additional avenue for making payment can provide a significant boost to this metric.
Invest in state-of-the-art practice management software
Whether you are trying to figure out which attorneys are driving the majority of revenue for your organization, or you want to know what areas need improvement to maximize your profitability. A holistic legal practice management solution is the engine that runs your firm’s day-to-day, from business to operation management, delivering the most important insights.
It allows law firms to create a complete picture of their finances when conducting a profitability analysis and helps them maximize their revenue. This means more than just time savings; it’s better to use billable hours to earn more revenue.
Discover how CARET Legal can benefit your profitability
Want to learn more about how real-time law firm reporting and analytics can benefit your profitability analysis? At CARET, we can help you simplify the management of your practice, thanks to our purpose-built platform.