In my previous blog in this series, we explored key performance indicators (KPIs) for measuring client experience with legal services. Satisfied clients increase revenue but many firms still fail because they do not pay attention to the business of timekeeping and billings. Recording hours, billings, collections and cash flow are all critical to business and therefore, to a firm’s survival. In this third installment, we focus on KPIs around collections that could increase your firm’s profitability.
Small law firms consider both matter and bottom-line profits to be important according to the Thomson Reuters’ 2016 State of U.S. Small Law Firms Report. However, as outlined in my first post in this series, the majority of firms surveyed on KPIs rely on bank balances or take-home dollars at the end of the month to measure profitability. Based on this information, I infer that a majority of firms are looking backwards when it comes to results. Not only is it too late to take corrective action if you wait to see how the month turns out, but a bank balance does not accurately measure profitability. Digging a bit deeper, we see that 18 of 31 law firms surveyed — which includes firms from all size groups — do not track KPIs. However, there is still time to set up your firm’s KPIs to measure and improve collections for 2017.
Traditionally, a firm pays staff and bills with some type of regularity, all likely within 30 days. Therefore, a firm’s accounts receivable (A/R) collections need to be at least within the same time frame to avoid running short on cash. Using an example from my book, Small Law Firm KPIs: How to Measure Your Way to Greater Profits, we calculate the average lockup days, which is a measurement of how long your cash is tied up from the date of time-recording to billing and ultimately to collections. The period between the time being recorded to actual billing is work-in-progress (WIP) lockup and the period from billed to collected is accounts-receivable (A/R) lockup. The law firm in the example below has cash locked up for a total of 41 days on average, with 21 as WIP and 20 as A/R.
Alternatively, you can start with a KPI that looks at the aging of the both WIP and A/R in total to check if you have an excessive dollar value outstanding over 30 or 60 days. Although target lockup days vary firm by firm, best practices would be to bill out as much WIP as possible within the same month as it’s recorded, and collect A/R immediately or within 30 days. Remember, your bills are due within a similar time frame and borrowing money incurs interest payments that will only eat into your profits.
Also, a final word on collections and compensation. In the KPI survey mentioned earlier, 18 of the 58 firms surveyed are looking at some metric of cost vs. budgeted or expected revenue, which is a good start when measuring profitability. However, when the same firms were asked if all the timekeepers had financial goals, only half answered “yes.” It’s hard to measure and reward profitability if there’s no accountability.
To illustrate the necessity of alignment between timekeeper and the law firm’s financial goals, we have an associate “Allan” who is recording hours and billing well above 100% traditional utilization, and thinking that he is deserving of a bonus at year’s end. However, some of his billings have to be written off at the end of the year as shown in the chart below. Allan has missed his target by 12% which, at a billing rate of $160, translates into about $41,000 of write-offs or lost cash. If Allan understands that his performance will be scored based on collections rather than utilization, then he will not be surprised when his bonus is negatively impacted.
One important caveat is that I am not suggesting that timekeepers should stop recording hours — that information is invaluable for pricing, including determining billing rates and flat fees.
It’s clear that there is room for implementing a wider range of KPIs for profitability, and that’s possible using existing software solutions regardless of firm size or geographic location. In fact, many of the newer KPIs do not require technology beyond Excel. Next, in our final blog of the series, we will examine how to create and track some client development metrics, including developing a potential client pipeline.