Part Three: Financial Management Building a Successful Law Firm
Updated: Aug 5, 2019
As the newly formed Law Firm Leadership Alliance, (LFLA), Gary Mitchell, Lisa Dawson, and Mayur Gadhia, have come together to collaborate on behalf of law firm leaders and law firms across Canada.
Following the topic of Administrative Management in our last article, Part 3 delves into finance optimization. Our 4 key areas of Building a Successful Law Firm include:
Practice Management
Administrative Management
Financial Management
Business Development
How well can your law firm answer these 3 questions:
What does your cash flow look like for the next week/month?
How close to budget are your actual income and expenses?
What is each lawyer’s realization rate/billable hours?
Your Law Firm is a business. That requires you to think and act like an entrepreneur. Most partners in law firms are expected to carry the brunt of business decisions with little formal experience running a business. This article is focussed on financial management, critical to a sustainable and successful law firm.
Traditionally, the financial performance depended on few metrics, such as billable hours, accounts receivables, and collections. However, in today’s highly competitive market, effective financial management also requires informed business decisions, a robust financial system that is focused on budgeting/forecasting, cash flow managing, key performance indicators (KPIs), and reporting. More importantly, your financial system must have the ability to generate tailored financial reports on a recurring basis and to interpret those reports to make strategic business decisions. Separately, there are certain compliance obligations from your provincial law society and Canada Revenue Agency (CRA) that should be factored in to your periodic reporting process.
Where to start?
Budgeting/Forecasting:
The budget is a GPS that ties the financial goals directly with the law firm’s broader strategy and simply forecasts revenue and expenses. There are numerous options to build a budget. However, for simplicity, consider downloading your income statement at the end of the fiscal year, align that with the firm’s vision and strategy, and develop a budget for the following year.
Revenue drives the budget. The projected revenue, by practice area, by timekeeper, and by rate of each revenue source is a good place to start. The projection can be made evaluating past matters in combination with new matters and new clients. In addition, the law firm should factor in dynamic and evolving market conditions that would impact each practice area such as changing regulations, financial markets, economic cycles, and client demographics. The resulting budget affects resource allocation and decisions.
Ask yourselves some simple questions: Do we need to shift resources to emerging or growing practice areas? Do we need to invest in document merge tools for document heavy and growing practice areas? If and where should we make investments in the short and long term?
The expense side of the budget is typically straight forward. Recurring costs are reliable. Expenses associated with Marketing, Technology and Capital Expenditures (CapEx), can easily escalate but, with a budget, can be held accountable.
Managing Cash Flow:
Depending on the nature of the practice or the position in the growth cycle, digging into credit for recurring expenses is not ideal.
There is a difference between budgeted net profit and forecasted cash flow. The budgeted net profit would normally exclude CapEx, partner distribution and/or contribution, dividend, loan transactions and advance client costs. Loose billing schedules and accounts receivables management, financing expenses and unmonitored vendor payments are indicators of poor cash flow management. Lastly, you need to plan for your obligations under Income and Excise Acts.
Just because the bottom line (i.e. net profit) is black doesn’t mean there is no red (i.e. cash flow fire drills).
Key Performance Indicators:
Successful law firms focus on robust financial metrics that measure broader financial performance. Fees collected (realization of the amount of time worked, recorded, billed and received), fees collected per lawyer, number of billable hours, and expenses as a percentage of revenue. Every firm should take stock of financial metrics based on their service offering and strategic vision of the firm. These metrics will drive behaviours both at the partner level and the staff level as these likely will drive compensation and bonuses.
Reporting:
CRA requires compliance with record-keeping requirements to support law firm’s filing obligations. In addition, each provincial Law Society has the ability to conduct mandatory audits of your books and records.
Seek a practice and accounting system that delivers reporting to your law firm leaders, providing them with the information that is easy to interpret and to determine your next actions and support your compliance obligations.
Successful law firms have their eyes on all of the above items and work with their CPA and other business advisors to identify and address issues on a timely manner.
As we say, it starts at and from the top. It is Law Firm Leadership that makes the difference.
Stay tuned as next month we delve into Business Development.