Financial management ratios

Law or other firms that offer client services, regularly start by measuring income through working hours by timekeepers. We emphasize the importance of entering the hours into a system or a spreadsheet, so that those hours can then turned into data, for analysis and decision making. It is crucial to look at these numbers every month, because those represent our work in progress and is our only “inventory”. And we also know that the income principals are the result of hours worked, billed and collected. Up to that point, more or less we are on the same page.

The numbers look good, employees are engaged and reporting daily or weekly billable hours, but, at the end of three different periods, with the same number of employees and the same fixed expenses, the benefit is not the same. So we start looking for the so-called "red flags" to identify why the income has dropped.

The reported hours represent a hybrid between billable hours attending clients and the hours dedicated to marketing activities or the so-called internal hours or “overhead”. For billable hours, we regularly set parameters or goals, which must be achievable and objective. We also leave a reasonable amount of time for internal non-billable hours. The objectives will depend on working week, but also on the benefits that the collaborators have, the flexibility, the number of vacation days or days off. Depending on the initial metrics, we should establish the parameters for the budget, rates and finally the individual compensation packages for each timekeeper, team member. The first parameter that we measure is the so-called utilization. It represents the relationship that exists between the number of hours we dedicate to work on matters and the established objectives. Percentages below 95% should already generate an “alert”.

The realization represents the value sent on the invoices divided by the standard value, billables hours multiplied by the standard rates. If we have systems, we can determine it also through hours. If working realization represents a percentage less than 90, it is already our second “flag”. Regardless of the billing method, per instance, per process, Retainer, or based on billable hours, the value sent on invoices directly affects working realization. As matter leaders, we are responsible for developing people and processes to keep this indicator under control.

Invoices are in the process of being collected and clients are beginning to ask for discounts. Generally, discounts of up to 3% of the total invoices sent in the period are acceptable. If measured as the percentage of standard value, collected cash should not be below 83%. Regarding the total of our accounts receivable, "alerts" represent the accounts older than 180 days whose value is 25% of the total accounts receivable that the firm has.

An important factor is monitoring the use of our liquid funds for expenses incurred on behalf of clients. If we do not have the systems and the right processes in place, monitoring can become inaccurate or demanding.

In the beginning, we mentioned work in progress. If the value of matters in the process is older than 180 days and represents 15% of the total value of work in progress, it is another "red flag" to avoid.

Sometimes there may be a wrong perception about benefits, relating them to income. Two law firms may have the same income, but the factors mentioned above directly affect the net profit that at the end of each period is left to shareholders for distribution.

The equation is also complicated because the law firms regularly distribute the benefits on the collected values. Generally Accepted Accounting Principles (GAAP) nevertheless do not admit cash nor modified cash basis financial statements. For the purpose of a better decision-making process, internally, partners receive two, using both methods, accrual, and cash.

Angelina Angelov