Obtaining the license to practice law is just the beginning. Running a successful and profitable legal practice or serving as a partner in a law firm requires more than just legal expertise. It needs specialized financial management and an understanding of profits to ensure money is not being drained. The way profits work in a law firm differs from that of other businesses. In a typical setup, net profit is calculated by deducting direct expenses from revenue. A law firm also calculates net profit similarly. However, in a profession like law, professional skill is your product that brings in revenue. Each legal case is unique. How you bill your skill determines your profits.
A law firm is either a sole proprietorship or a partnership. The most significant expense – a partner’s compensation – is not accounted for as a salary or wage that you deduct from revenue to arrive at net profit. Hence, your net profit margin might appear inflated, especially when there are multiple partners.
Lack of understanding around profits could be draining your hard-earned money. Insights into your billables and a tweak in your work can bring significant cost savings and boost profits, which is the focus of this article.
How Net Profit Margin is Calculated
Revenue: In legal practice, there are various types of revenue models, including billing by the hour, fixed fees for specific services, and fees based on high-value clients and corporate clients that require premium services, as well as fees depending on the case type.
Many lawyers running individual legal practices often confuse revenue earned as profits. They fail to consider various overhead expenses, as well as the working hours of other staff members, including receptionists, sales personnel, customer acquisition teams, and networking costs. When calculating revenue, ensure you include all these costs.
For instance, Mary is a divorce attorney, and she calculated billable hours only for the time she spent on the case. She failed to include the billing hours of her receptionist, who spent time gathering basic information before the consultation, communicating case updates, and providing other necessary services.
Expenses: When it comes to expenses, a legal practice incurs costs for an attorney, a paralegal, and associates, who are direct expenses as they work on the case. Then there are indirect expenses, such as office supplies, rent, internet, and meals, categorized under overhead expenses.
If you take the overhead expenses and divide them by the number of revenue-generating employees, it would be misleading. This is because the budget and facilities used by a senior lawyer and a paralegal differ. They both generate revenue, but a senior lawyer may use an expensive laptop and a marketing budget, while a paralegal only needs a desktop computer. Hence, it is crucial to allocate overhead expenses to individual lawyers.
Strategies to Manage and Improve Net Profit Margin
Calculating Net Profit by Case Type
Lawyers determine the net profit margin of a law firm, while that for an individual legal practice is determined by each case. Many individual lawyers make the mistake of not separating the subject matter when calculating the profit. For instance, Jerry is a property lawyer and mainly handles property registration and estate planning matters. The transfer of estate generates higher profits, but most of his cases involve lower-margin property registration, thereby reducing his profit margins. An insight into profitable cases can help Jerry target the proper case and charge the right amount.
Streamlining Operations to Cut Costs and Optimize Billable Hours
Many lawyers bill by the hour, which not only includes their own hours but also those of their administrative staff. Various software can help you derive insights into the billing hours and the staff utilization rates.
For instance, Mary had hired a full-time associate whom she was paying for 40 hours per week. After reviewing the billing hours, she found that the associate’s job was only 10 hours per week. Here, the staff utilization rate is only 25%. She can utilize this insight to streamline operations, such as outsourcing work to a third party and being billed only for the hours worked, hiring a part-time employee, or allocating more work to the associate. If Mary is spending a lot of time on unbillable or low-value work, she can allocate that to the associate and focus on high-value work. This will free up her time to take on more cases and boost profits.
The legal profession is time-consuming and mentally draining, as it requires reviewing past cases, documents, and reference books. This leaves you with little time to sit and analyze financial statements, payroll, calculate profits, and identify inefficiencies. All this is a non-billable task in legal practice.
Contact Black and Gill LLP in Etobicoke to Help You with Accounting and Financial Planning
A legal professional may consider seeking the help of a professional accountant who is well-versed in crunching numbers, setting up invoice and payroll systems, analyzing statements, and performance indicators. At Black and Gill LLP, our accountants can provide services such as preparing customized financial statements, calculating net margin, and advising ways to improve it. To learn more about how Black and Gill LLP can provide you with the best accounting and financial planning expertise, contact us online or call us at 416-477-7681.