1	Enronomics for Law Firms: Making Sense of the Numbers Presented by Stephen M. (Pete) Peterson Law Firm Business Institute Wednesday 2:00 – 5:00 p.m. ALA 32^th Annual Education Conference San Diego, CA
2	Session Contents Methodologies for improving the bottom line Sample applications Other key financial measures How to improve your management reporting Translating the mass of financial statements and data to meaningful, short reports
3	Objectives Provide a high level of understanding of significant drivers of law firm profitability Provide understanding on what methods yield the greatest improvement to the top line and bottom line Provide ideas and examples for management reporting
4	“Accounting has become the most intellectually challenging area in the field of management, and the most turbulent one.” -Peter Drucker
5	A Few Good Accountants Tom: Did you order the shredding? Jack: You want answers? Tom: I think I’m entitled. Jack: You want answers!! Tom: I want the truth! Jack: (to be read at session)
6	Should Law Firms be Run Like a Business?
7	Do Law Firms Employ Questionable Tactics? Well, some firms have… Finley Kumble Keck Mahin & Cate Others who take from the poor and give to the rich Referring to client trust fund abuse
8	Law Firm Economics
9	Economic Drivers R U L E S Represents the primary and key statistics that measure and monitor the financial success of a law firm
10	RULES R-rates/revenue/realization U-utilization L-leverage E-expenses S-speed What do they mean to you?
11	RULES Have Many Applications and Include: Providing information for strategic planning purposes Determining profitability and at various levels-client/matter, practice group, etc. Where to invest the firm’s limited resources, such as Industry segments/practice areas Marketing or technology endeavors Assessing merger candidates and lateral hires
12	“R” Factors “R” Factors Rates—assuming we can increase rates in this environment Revenue—what other methods can be employed to increase fee revenue Realization—measuring the impact of premiums, discounts and write-offs
13	“U” Factors “U” equals Utilization—statistics which track how busy our fee earners are on billable files Very important to track in order to: Determine growth needs Manage leverage (and resource allocation) Project future fee revenues Determine if hoarding is taking place Only improved only by increasing amount of work or decreasing number of fee earners
14	“L” Factors “L” equals leverage Leverage statistics measure the ratio of all non-equity attorneys to equity partners (traditionally this was the old associate to partner ratio) All things being equal, average partner income increases as leverage increases
15	“E” Factors “E” equals expenses Expense controls are a needed element in determining the profitability of a firm From 65% to 75% of total firm expenses are people and facilities Need to start thinking “small office, big house” This is one category that your partners are happy to help you with
16	“S” Factors “S” equals the need for speed Particularly the speed of billings and collections Generally speaking, aging is good for wine, beef and certain cheeses Aging is NOT good for WIP and A/R Delays decrease realization and cash flow Which in turn increases interest expense
17	Realization-Turning Worked Values to Cash Standard billing rates = $100 Fees actually billed = $ 90 Fees ultimately collected = $ 80 -Billing realization = $90/$100 = 90% -Overall realization = $80/$100 = 80% High profit firms achieve realization of 96% or better.
18	Improving Realization is Key for Improving Bottom Line Results Increasing realization from 90% to 96% for firm with $50 million in revenue Yields $3,000,000 to the bottom line Increases per partner income by nearly $60,000 (assuming 50 partners) Normally, no expenses incurred for increasing realization
19	Improving Realization Speed Time entry Billing Collecting Alternative billing methods There is an upper limit on billable hours Client intake procedures/policies Being cognizant of troublesome industries Client communication
20	Improving Realization- the Billing Cycle Timing Process and mail by date certain Bill while there’s a tear in the client’s eye Communication-invoices contain perception of value Use greenmail messages Employ a default system
21	Improving Realization-the Collection Cycle Firms need to adopt and employ collection procedures and polices The passage of time is detrimental to collections Do not allow invoices to “marinate” Shrinking dollars affect After 30 days, a dollar is worth 90 cents After six months, it’s worth 57 cents
22	Discounting/Write-offs Discounting is costly For example, a 10% discount for a firm with a 40% profit margin actually costs 25% in terms of loss to the bottom line. Cost of replacing the value of services written off A $40,000 write-off needs $100,000 in new fees to replace lost income
23	Minimizing Adjustments Is the new matter eligible for alternative billing arrangements? Need for stronger matter management Better supervision over work Timely, clear and consistent communication with the client Type of work Have we done this before thereby benefiting from knowledge management? Or, is this a green cow with purple dots?
24	Cyclical Nature of Write-offs
25	Typical Collection Cycle (in thousands)
26	Timing of Most Write-offs and Adjustments
27	Per Partner Write-offs by Year
28	Utilization—A Measure of Overall Productivity and Capacity
29	Effects of Leverage on Profits As previously noted, average partner income increases as leverage increases This assumes a number of key points: Each non-equity attorney contributes something to profits Need adequate utilization Need adequate realization Mix needs to include substantial number of mid-level and senior associates
30	Expenses Blinding flash of the obvious—reducing expenses combined with a flat or increasing level of revenue results in increased profits You need to monitor expenses but don’t get carried away
31	Typical Cost Structure Largest costs People Occupancy
32	Speed Time is always of the essence Just ask your clients From the time it takes to open a file to the collection for services rendered By far the easiest thing to correct Yet often overlooked Lack of systems and discipline
33	Speed Speed issues—you must review these 2 statistics: Aging of WIP and A/R Reviewing all significant accounts over 30 days old Number of months or number of days invested in WIP and A/R
34	Investments In WIP and A/R
35	An Exercise in the Manufacture of Money and Profits
36	ABC Law Firm Profile Annual revenue of $22,500,000 Average hours of 1,650 Average rate of $225 Realization of 87% 60 attorneys Leverage 1:1 Profit margin of 30%
37	Hypothetical Illustration of RULES Improvement
38	New Key Financial Terms From FIFO and LIFO To FISH From GAAP Generally Accepted Accounting Principles To PCAP Politically Correct Accounting Principles
39	Profit: An archaic term no longer in use. See Enron, Worldcon, Kmart, HealthSouth, United Airlines, Xerox, etc.
40	What Are Law Firm Profits? Net profits Tells us nothing without further review Profit Margin Commonly used but not very useful Profits per Partner Also commonly used and accepted Can be misleading What partners are you including?
41	Reviewing the Net Margin Can be very misleading What is an acceptable net margin? Depends on a number of factors: Cost structure, locations (S.D. vs. S.D.) Leverage Utilization Realization Pricing
42	How Leverage Affects the Net Margin Firms can have a high net margin but low average profits per equity partner (PPP) Because of lower leverage Firms can have a high net margin, low leverage and high average PPP Because of multi-tier partnership structures Firms can have a low net margin but high average PPP Due to higher leverage
43	How Other Factors Impact the Net Margin Firms with a higher realization combined with cost structures and leverage of similar firms will have a higher net margin Same holds true for firms with better utilization Other factors include type of work, pricing of work
44	Illustration of Net Margins
45	Understanding the Numbers Provides You With a Creative License
46	Management Reporting Considerations Provide more in the way of knowledge, less in the way of data Use simple presentations: Use “drill-down” technique if overly complex Answer the 5 W’s Present reports that reflect what the partners need to know: You need to determine what data the partners need to know and understand And then, educate them on what they need to know and help them interpret results
47	Who Gets What? Management committee--more detailed Partners—condensed reports reflecting one-firm reporting Practice Group Leaders-generally same as management committee but for their group only Associates Staff Management
48	Sample Presentation to the E.C. Review current period financial statements Include an introduction piece Drill down on certain expenses Provide other key information: Utilization Realization Staffing and leverage Investment in WIP and A/R
49	Commentary on Current Period Results Hours are behind plan by 2,148 Need to focus on improving billing and collections—behind plan by $192k Experiencing softness in 3 practice groups Also experiencing some slippage in realization Expect productivity improvement in 2^nd and 3^rd quarters Some negative expense variances due to timing issues Staffing levels are temporarily high Projected results look good and but we might expect to fall short of plan by $215k
50	Balance Sheet Highlights
51	Income Statement Snapshot
52	Operating Expenses
53	Cash Flow Statement
54	Practice Group Utilization (reporting version A)
55	Practice Group Utilization (reporting version B)
56	Leverage and Staffing
57	Investment in WIP and A/R (by Practice Group)
58	Practice Group Realization
59	Questions/Comments
60	Opportunity for Follow-up Law Firm Business Institute Stephen M. (Pete) Peterson Managing Director pete@lawfirmbiz.com T: 303.981.1118 F: 970.626.2226