You say your law firm is profitable. How do you know?

In addition to providing clients high-quality services, partners strive to strengthen their law firm's financial prowess. Higher profits may contribute to increases in partner compensation, enhanced benefits, greater ability to attract and retain top talent, and competitive edge. But how do you boost profitability without raising fees, or requiring employees to work more hours?

To fully understand your law firm's results of operations and financial condition, you should measure and examine key performance indicators (KPIs) on a granular level. Looking beyond high-level KPIs can provide actionable information to make operational and strategic decisions, and answer questions such as, “Why is the bankruptcy litigation practice in our Boston office more lucrative than our Miami office, when the latter has twice as many attorneys?”

A strong grasp of your law firm's performance is essential as law firm mergers and acquisitions stimulate competition across the industry. Fifty-two combinations were announced through mid-year, according to Altman Weil MergerLine, slating 2017 as another record-breaking year for U.S. law firm mergers and acquisitions. Even if your firm doesn't plan to engage in M&A activity, you should have a strong understanding of your firm's performance to thrive in this increasingly competitive environment.

To gain a stronger understanding of what impacts your law firm's performance, you should actively track, analyze and communicate KPIs, particularly in relation to productivity, finances, client success and operations. These key metrics will arm firm management, partners and chief financial officers with data-driven insights to make prudent business decisions.

Gather Strong Data with Accrual Accounting

It's difficult to measure KPIs and make critical business decisions without data. Many firms rely on the cash method of accounting. Though explicit and clear-cut, this method doesn't account for all the factors that affect the firm's operating results and financial condition.

Accrual accounting paints an insightful picture of the firm's operating results and financial condition by recording revenue when earned and expenses when incurred. Accrual accounting would record accounts receivable (A/R), works in progress (WIP) and accounts payable, giving you a stronger understanding of the firm's overall performance.

The more detailed and pertinent data you have on hand, the more factors you can take into consideration when evaluating KPIs on a micro-level. The KPIs below can help you provide senior leaders with solid insights regarding firm productivity, finances, client success and operations.

Productivity KPIs

Do you know how much time professionals are devoting to billable work? Imagine you're struggling to boost productivity among attorneys in your real estate litigation practice. Why are their billable hours lower than usual? Are they spending more time than needed on administrative tasks?

Examining productivity KPIs on a micro-level can provide insights for maximizing attorneys' billable hours and may spur decisions to boost attorney performance, reassess staffing structures and more.

• To measure firm's leverage: |
  • Ratio of full-time equivalent (FTE) associates to partners
  • Ratio of partners' hours to total billable hours by all-time keepers
  • Tip: Split metrics above between equity and non-equity partners if applicable
• To measure billable hours: |
  • Ratio of billable hours to standard hours, for any or all of the following: attorney (associate, non-equity and equity), paralegal, practice area and office
• To measure billable hours per legal assistant: |
  • Ratio of total billable hours for all professionals to number of legal assistants
  • Tip: Benchmark by practice area or office if applicable
• Administrative staffing levels |
  • Ratio of total number FTEs to the total number of FTE professionals
• Utilization |
  • Ratio of fees billed to fees incurred
• Realization |
  • Ratio of fees collected to fees incurred
• Average daily fees generated |
  • Total billable value/Working days
• Average daily fees billed |
  • Total fees billed/Working days
• Average daily fees collected |
  • Total fees collected/Working days

Financial KPIs

How lucrative is each office and practice? Should your healthcare practice devote more time to HIPAA compliance or healthcare fraud? Are clinical research agreement services worth pursuing in your Dallas branch?

Financial KPIs reveal how much value your offices, service lines and employees bring to the law firm individually and collectively, depending on how you look at the data. Pay close attention to these metrics when creating budgets and considering strategies to cut costs and streamline processes.

• Profit available to partners as a percentage of revenue |
  • Partner profit pool divided by firm revenue, presented as a percentage
• WIP days outstanding |
  • Number of calendar days unbilled WIP
• A/R uncollected days outstanding |
  • Number of calendar days outstanding AR
• Average cost recovery |
  • Ratio of costs billed to costs incurred
• Contingency WIP |
  • Ratio of contingency-based WIP to total WIP
• Trends in overtime payroll |
  • Ratio of employee overtime hours or $ (for employees subject to overtime pay) to total employee hours or $ (for employees subject to overtime pay)

Client-related KPIs

Can you name your top clients? Imagine that your dispute resolution team has worked diligently with the same client for several years on complex commercial litigation matters. Is there a ripe opportunity for your business and tax team to assist this client on corporate restructuring as well?

Taking a deeper look at client-related KPIs can reveal the firm's most valuable relationships across practice areas — in addition to those exhausting your resources.

• Breadth of client relationship |
  • Number of matters per client
  • Number of practice areas that support this client
  • Number of professionals with time spent on matters connected to particular client
• Average fee per client |
  • Ratio of total $ fees to total number of clients
  • Ratio of the total $ new client fees to total number of new clients
• Trends in client growth rate |
  • Ratio of the number of new clients (by practice area) to number of total active clients

Operational KPIs

Recurring business expenses should be examined on a micro-level to identify potential cost-saving measures, as minimizing overhead costs can positively impact your law firm's performance. For example, does your Miami branch of 30 employees really need a 7,000 square-foot office, or can it perform just as effectively with less space?

The KPIs below address these operational areas and also reveal the marketing and business development teams' impact on profitability, especially when management is considering cutting or increasing budgets for these departments.

• Total exposure by client matter or group |
  • Total number of calendar days invested (sum of days in WIP and AR)
  • Total $ WIP, AR, plus hard and soft costs per client matter or group
• ROI/Utilization of space |
  • Revenue per square foot by location
• Overhead factor |
  • Overhead expenses expressed as percentages of revenues
• Marketing spend |
  • Ratio of total marketing spend to total fees billed
• Business development spend |
  • Ratio of business development spend to total fees billed or prospect pipeline
  • Tip: This may be more useful to benchmark by practice area, attorney or office

Taking Action with New Insights

When tracked properly, KPIs can help partners better comprehend their law firm's profitability and provide actionable insights to guide strategic and operational business decisions. Proactively establishing and determining KPIs can help you discover answers to complex business questions, in addition to maintaining a competitive edge. Measuring and examining KPIs on a micro-level may be daunting at first, but keeping business goals and profitability in mind can provide the extra “push” to spur change beyond the boardroom.

Steven A. Davis, CPA, is an entrepreneurial services principal at Kaufman Rossin, one of the top 100 CPA and advisory firms in the U.S. Steve can be reached at [email protected]. Tyler Quinn, CPA, CISA, is an assurance and advisory services principal at Kaufman Rossin. Tyler can be reached at [email protected].