Is your business headed for a fiscal cliff, most corporate CEO’s have a pretty good measurements to help guide them from falling off the edge. However, law firms are somewhat strange and operate quite differently from the Fortune 500 companies.
Here is a short check list to help a firm see a potential fiscal cliff before falling off:
- Don’t let current financials fool you. Law firm financial statements don’t always provide a true view of profitability, they are cash based. They try and match up cash collected today from work done long ago, along with today’s expenses. This cash may have resulted from clients and partners who are no longer even associated with the firm. Pretend you are recognizing revenue and costs based upon the accrual method of accounting, compare that to your cash basis results. This can be a simple calculation, just take the historic realization value of the hours worked this month and subtract all of your true costs for the same for the month (not just what you paid) and this should give you a comparison. Is your firm healthy?
- Closely examine forward looking indicators. In a law firm, forward looking indicators include:
- Review total hours recorded this month or quarter and the value of those hours at their potentially billed and collected value;
do not calculate any of this at standard rates.
- Can you project out a backlog; does your firm have enough work to become 90% utilized over the next 3-6 months?
- How satisfied are your clients, are you winning the client swapping battle? How dependent are you on key clients in any one
sector of your business.
- What is the economic climate in your client’s market place? How will this affect your future work and your ability to raise
- Worry about the mix. The business mix of law firms equate to the product mix of a corporation. It can be critical. Compare your current and forecasted mix with historical values. Do this by type of law, in other words are you getting more business in transactional litigation with lower rates while your patent litigation is slumping. Take a close look at your associate to partner mix, are you actually forcing work down to the lowest practical level?
- Look at the trends. All the measurements we are discussing here must be looked at from a trending point of view. Most law firm financial reports are “point-in-time” snapshots, what does the trend look like? Keep on-going trends spreadsheets for hours, effective rates, cash, write-off’s and expenses. It would be helpful to keep these by practice group and branch office. These trends will help you look forward, instead of just backwards.
- Culture, Lateral Partners and Acquisitions. We have all seen the demise of law firms over the last few years and there are many things we can learn from this experience. Many of the firms that have imploded were a result of either falling off a fiscal cliff or culture issues. Let’s talk about the culture issues, is your firm playing on the lateral partner “merry-go-round”, whereby you lose a partner but
gain one from another firm? There is a huge financial and cultural risk associated with growing by lateral partners. The larger a firm becomes, the more the culture fractures especially if the growth comes through acquisitions. A fractured culture can quickly turn on a firm and once a group leaves, it can be like a cash-run on a bank … deadly.
Pay attention to the list above and you’ll have a better chance of seeing and avoiding a fiscal cliff in your business.