Making Money: Your Practical Guide To Profit
by Ed Poll
Most people agree that law is a profession while lawyers must act in a business-like manner. Clients demand this. Thus, there is no room for debate, as in previous years, as to whether lawyers are professionals or business folks. They're both.
In business, owners seek to make a profit. This is not a dirty word. Without profit, you can't engage and pay others to work for you, put food on the table, take care of your family, and effectively represent your clients who deserve your complete attention.
The purpose of this article is to provide ideas to get you to that point where you're making a reasonable profit so that your real and primary focus shifts to your clients.
Before we get into the nitty gritty of practical tips for creating more profit, an important question needs to be asked: How do you know if you're making any money? There are a number of "measurement sticks" that can help you determine, as you go, whether we're on the right track or not. Here are five of the most important ones:
Profit & Loss StatementIn this case, I'm talking about a cash statement or a cash P&L not an accrual P&L. Accountants in manufacturing and many other businesses like to talk about accrual (accruing or accumulating during a specific time period; not related to when the cash is actually paid or received). For our purposes, what we're talking about is very simple: cash in and cash out.
The profit and loss statement is simply structured: Revenue less expenses equals profit. It is usually seen as:
Thus, the first area is Revenue. How much money comes into the office and gets deposited into the bank.
The second area is Expenses, both fixed and variable. Fixed expenses include things like rent. Others are more variable, including how many people you employ. Growing businesses need more people and more things. Those are all variable expenses.
The third and final part of a P&L statement is Profit. And again, this is cash; the cash that's in your pocket at the end of the day, the end of the week, or the end of the month (after you have paid/sent out checks for expenses).
Utilization RateIn larger firms, associates frequently have billable hours targets from 1,900 to 2,200 hours per year. Assume, for example, that the target is 2,000 hours. If the actual hours billed are 1,850, then the utilization rate is 92.5 percent. If this were a manufacturing environment, it would be said that you didn't work the plant to 100 percent capacity. By not meeting the goal of 2,000 hours, you utilized your capacity (this assumes that you were capable of reaching the 2,000 hours; that it was not an unrealistic goal) to only 92.5 percent.
RealizationOne definition of realization is the familiar term collection or collection against billing. A good realization rate should be over 95 percent. In other words, if you've billed something, you need to collect it. Otherwise, whatever you don't collect becomes a bad debt or a "write-off."
I had one client who couldn't figure out why they weren't growing any faster. They hired a marketing consultant, and she came in and said, "this firm is doing pretty well in terms of marketing, so there's something else wrong here." Then they brought me in. Very quickly, I determined that their realization rate was horrible. They were collecting 68 cents out of every dollar that they billed. Now, if you've got a 32 percent write-off, you're definitely in trouble. The issue for them was not marketing; the issue was collecting, and they didn't even realize it.
The second definition of realization is: what's billed versus what's recorded. In other words, if you record eight hours of billable time a day, but for whatever reason you bill only six of those eight hours, then in terms of billing versus recording, your realization rate is only 75 percent. If your work is good enough, and if your client understands the value that you're producing, then you should be billing 100 percent of what you record.
Accounts Receivable and Work-in-Process AgingAn accounts receivable aging report tells you how much clients owe you and how long that amount has been owed. If you continue to work while your clients continue to increase the accounts receivable, then in essence, you're doing pro bono work, but itís the client's decision, not your's.
Cash Collection CycleThis means how fast you can turn over your accounts receivable. In other words, how many times a year can you actually collect. If you bill on a thirty-day cycle, and your clients pay you every 30 days, your cycle is 30 days. And you'd collect your receivables 12 times a year. The faster you collect your accounts receivable, the more money you're going to make.
Practical Tips for Profit
Now that we've laid the groundwork for how to keep track, let's get into some specifics on how you can actually create more profit for yourself, and how those measurement sticks can be at their highest points.
Create a plan
Set aside some time to actually create a business plan. (For assistance, take a look at my book, The Attorney and the Law Firm Guide to Business of Law 2nd Edition (ABA, 2002), or my workbook, The Profitable Law Office Handbook: Attorney's Guide to Successful Business Planning.) Without a business plan, you cannot succeed except by accident. If you don't know where you're going, how will know when you get there? Famous coach John Wooden said to his basketball team that, "Failing to plan is planning to fail." Yogi Berra put it in a more humorous way, "When you come to a fork in the road, take it." Without a plan, which fork are you going to take?
Start creating your business plan by writing down your personal goals. Write down three personal goals that you have for yourself in the next 6 to 12 months. When finished, turn that page over and write down three goals that you have for your professional work. As an attorney, what are the three professional goals for the next 6 to 12 months?
One caveat: These goals need to be meaningful and helpful for you. Use the SMART formula: The goals must be Specific, Measurable, Achievable, Reasonable, and Time-specific. If you say, "I want to make more money," and somebody gives you a penny, then you've made more money. But, that's obviously not what you had in mind. By looking at each of the elements in SMART, you will create goals that can be achieved, and you will know that you've achieved them.
Once you have your goals, create the second component of a business planóthe marketing plan. Basically, all a marketing plan does is tell you how get from where you are to where you want to be. That's all. It's not advertising. It's not P.R. It's not brochures. It's all of those things, and more. It is the mechanism to help you realize your professional goals.
If you are pro-active rather than reactive in terms of marketing, you will be more effective and experience a faster increase in revenue. Most of us go through our career and wait for folks to knock on the door. However, today, lawyers face a very competitive environment in which legal services oftentimes can be obtained over the Internet with little or no cost. Aside from the fact that there are more attorneys practicing now than ever before, there is also technology that enables further competition for your services. So, you have to be more pro-active. And one way to do that is by creating a marketing plan.
Marketing is no longer an option. The only issue today is whether you do marketing well or poorly. From the moment you awake to the moment you go to sleep, you are marketing. What I mean by that is that marketing can easily be defined as the attempt to persuade somebody to the validity of our ideas. Every time you go into court, you're marketing. What are you marketing? You're marketing your concept of the case. You're trying to get the judge or the jury or both to see your point of view, to accept your position of the case. Every time you meet somebody, that's a prospective client or a prospective referral source for you. And if you fail to take advantage of that, you're missing a marketing opportunity. If you are pro-active, rather than reactive, you will have more business.
I suggest you get a flat calendaróthe type you get around the New Yearóthat has 30 days at a glance. Take that calendar and do nothing else with it except put it on your desk and mark on it, day-by-day, things to do that are specific to marketing. I mean ordinary things like, "Call John today to set up lunch for next week." "Prepare an e-mail newsletter to be delivered two weeks from now." Simple things. But make sure your calendar has one, two, or three things on it every working day. If you do that, you'll become far more conscious of marketing.
The third element of a business plan is very simple: Create a financial plan. Put some numbers to it. How much money is going to come in and how much money is going to go out. And, get even more specific. In what month will the money come in, and in what month will it go out?
Most people find the idea of creating a revenue projection to be very difficult. "How do I project the future?" they always ask. I suggest you look at your expense side first because that's something that's easier to figure out. We generally know what our expenses are. And, when we're not sure, we can go to our checkbook (or QuickBooks, etc.) to see how much we spent last month or last year. For example, we know how much rent we pay, we know who our staff are and how much they are paid, and so forth. Also, determine how much money you will be spending for your marketing activities and insert those numbers in a spreadsheet along with the financial information for your other expenditures.
Looking at the revenue side, you will just have to make some educated guesses. You have more information than you may think. For example, "I've had a certain history of revenue received; I know what I've taken in in previous years, month by month." You will also know whether your revenue is or is not growing. Further, you know if your revenue is impacted by the time of year. Some practices, such as family law, have a definite season (to some extent); custody and visitation increase in November and December; divorces increase in January. Thus, you can make some reasonable guesses about how much money you will receive and in what month of the year you will receive it. This information will enable you to create a revenue projection.
Qualify Your ClientsI once worked for a large law firm, and they had to write off the billings of several clients, each of whom had three or four hundred thousand dollars in accrued receivables! That's a huge number, even for a large firm, to write off. And the reason they did this is because they never bothered to qualify the clients during the intake process. They forgot to ask the clients how much they were willing to spend to pursue their matters. Basically, the firm forgot to check out the economic viability of the clients. Instead, and because the fear of malpractice had them covering every base they could conceivably think of, they ran up big bills. And the clients said, "Wait a minute, for what that matter was, you're not entitled to that kind of a fee." And they refused to pay it.
The moral of this story: When you get a new client, make sure you qualify them first.
Raise Your FeesChances are, your fees have been at the same level for a long time. How do you raise them? One of the keys is to do it in small amounts, like $5, $10, or $15 at a time, done once a year or once every 18 months. That kind of incremental increase will seldom offend anyone or cause a client to leave you for another attorney. They understand that costs are increasing, but whether they do or not, think about raising your fees if you think your market will accept it.
Price Your Legal Services RightWhat the Market Says: How you price your services is dependent on a number of things, one of which is: what is the market telling you? In the 1960s, the Bar Association could tell us what a reasonable fee was. This was a great tool for new lawyers in order to figure out what the market was charging for particular services. However, the Supreme Court said that was price fixing, and this no longer happens today. But, you can still gather the information by talking to your colleagues, by being active in your Bar Association, by having a network of other lawyers. You can find out what's being charged in your market, and then react accordingly.
What Type of Practice is it? Another important aspect of pricing is understanding what kind of practice you have. Is it a commodity practice, such as consumer bankruptcy, low-income family law, or personal injury? Or, do you have a bet-the-company type of practice handling one-of-a-kind cases? You need to clearly understand what type of practice you have in order to determine what your pricing should be.
By the Hour, or...? Hourly is not the only way to bill. Another popular way is to create a laundry list of charges and, when you have a written fee agreement, attach that list to the agreement. And by laundry list, I mean things like: half-day deposition costs "X," a Petition for Dissolution of Marriage costs "Y," and so forth. You have fixed prices for each element of what you're doing.
Obviously, you can't do that for everything you do, but you can certainly do it for many repeatable services. Why is this a good idea? First, the client will know up front what it's going to cost. Second, if you are charging by the hour, you'll eventually fall into the Technology Trap, which goes like this: You spend more money investing in the technology, you become much more efficient by using that technology, and you can now do your work faster. What is the result of these improvements if you're still charging by the hour? You charge your client less, which means you've got to get two clients for the work you used to do for one client!
If, however, you have a laundry list of fixed prices, then you can become more efficient, but you won't be losing money since you can now do more work in the same amount of time. Think of it in terms of the assembly line. When Ford or Chevy improves their efficiency, do they lower their prices? No. They seek to take advantage of the efficiencies that they're able to create. Lawyers ought to be able to do the same thing.
Start Thinking More in Terms of Value Billing. Here's a real-world example of how general counsel who had gotten accustomed to the billable hour learned to appreciate the concept of value billing.
A large firm was dealing with a big bank in a major litigation. The outside counsel wanted to file a motion for summary judgment. The firm went to the client, the general counsel, and said they wanted to prepare and file this motion. General Counsel said, "I don't think we're going to win, and I don't want to pay for an exercise in futility." The outside counsel was so convinced of the value of the summary judgment that they got creative. They made an offer to the general counsel, saying, "Look, our normal rate is $300 per hour. We will charge you $150 for all the work on the motion for summary judgment, including the hearing. If we lose, you don't owe us anything more. But, if we win the motion, we want $600 an hour." General Counsel agreed to the deal. When the time came for the general counsel to write the check, he had no problem paying the $600 an hour since the motion for summary judgment resulted in a total victory for the bank. That's value billing.
Remember, it's the client's perception that determines value.
Do Your Billing RightSend your bills out regularly. The end of the month is best. Do not wait until the third, fourth, or fifth day of the month. Thatís when your client should be receiving your bill. If youíre dealing with businesses, around the fifth to the tenth of each month is when they cut off their accounts-payable cycle. That means that they'll put your bill in their cycle for the following month, not for this month.
Make Your Bills Understandable and Positive. Your clients need to understand the bills, so make sure they're in English, not legalese. And, as a corollary to that, put a positive spin on your bill. In most tasks that you perform, thereís usually something positive, something of value thatís given to the client that you can talk about. Donít hide the negative stuff, but start with the positive. Your clients will pay their bills faster if they think that theyíve received value from you, and they wonít know that unless you tell them.
Here's an example. In a family law matter, you represent the husband, and there's a $10,000 per month temporary custody and spousal support order issued by the court. Thatís a big number, and it's going to hurt the client, economically as well as emotionally. However, maybe you succeeded in getting visitation rights that the client wasnít expecting, or that he feared would be taken away from him. So, in the billing, start with the visitation rights, and then end up with the financial award.
If you accept credit card payments, youíre going to get paid faster.
Concentrate on Revenue, not ExpensesOverhead is a big issue, but, thereís only so much you can cut. When you focus only on expenses or overhead, you become obsessed with that because itís something you can understand. But, when you cut too much, youíre cutting the muscle, not just the fat, of your practice. This could be the muscle that you may need for an increase in clients or for matters in the near future.
If you want to make more money, think mostly about increasing your revenue. Figure out ways to target the right kind of client to get the right kind of work that will bring in the higher revenue. When you make more money, the costs will take care of themselves.Reprinted from the October-November 2004 issue of Law Practice Today.