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Is Your Firm “Realizing” Its Potential?

It’s that time of the year again. Firm tax returns are being filed, partners are looking for distributions to cover their personal income tax obligations and firm management and the finance committee are looking for ways to boost profits and cash flow for the current year. This leads to firm management looking for ways to improve performance for the upcoming year.  Too often, there is a desire to tell everyone to increase billings, obtain more clients and offer or cross-sell new services. However, for most firms, there are challenges in increasing demand for their services and addressing the current level of fee resistance in the market place.

Identifying and understanding a firm’s key performance metrics is a necessity for all law firms.  These metrics must be reviewed and analyzed on a continuing basis to assist in improving the overall financial health and profitability of the firm.  An example of a key metric to law firms is “realization” which has various elements and is a key indicator as to whether the firm is actually earning what it believes it is earning. 

 

Billing Realization Rate = The percentage of time worked on a client that is billed to the client.

Collections Realization Rate = The percentage of fees billed that is collected.


While increasing billings and billing rates are often identified as the solution, it is not guaranteed that these will lead to increased profits.  When combined with an effort to manage realization, they are more likely to have a positive impact on revenue and earnings. 

Many firms raise their billing rates year-after-year to increase their top line only to have those efforts offset by fee concessions or accounts receivable write-offs, both of which negatively impact a firm’s overall realization rates.   This practice is counterproductive to increasing firm profits and can effectively negate the intended impact of the fee increase.

The anticipated result from a firm’s increase in billing rates will also be challenged if billing partners have an unwillingness to pass on the increases.  Reasons for this hesitation, amongst others, include concerns about the fairness of the fee increase or worries about losing the client.  The bottom line is that when the firm’s standard rate goes up and it is not billed in accordance with firm policies, any potential for an increase in a firm’s overall realization rate is challenged by increased write-downs.

Impact of Realization and Billing Rate Increases:

The following table demonstrates the impact of 1) increasing realization by 3% and 2) increasing billing rates by 3% percent without improving realization:

   Base case Increased realization     Increased billing rate
 Total fees  $1,000,000  $1,000,000    $1,030,000
 Realization  85%   88%  85%
 Net fees  $850,000  $880,000  $875,500

    
The above table illustrates that either an increase in realization or an increase in billings rates may have a positive impact on net fees.  What is interesting in the example is that an increase in the effectiveness of an engagement provided more to the net fees than a fee increase. 

Should a firm be able to combine an increase in the realization with an increase in a billing rate the results would be as follows: 

 Total fees   $1,030,000
 Realization  88%
 Net fees  $906,400

    
An additional profit of $30,900 is generated by layering on an increase in the realization rate on top of a billing increase.  The net result of increasing realization and billing rates each by 3% results in a net fee increase of 6.6%, which indicates the importance of both realization and billings rates on a firm’s profits and cash flow.

Understanding the impact of realization is one thing. Knowing what to do and how to implement a plan to improve realization is another.


How to Improve Realization Rates

To Improve Billing Realization:

  1. Establish and communicate regularly the policies designed to tighten up your firm’s timekeeping practices. 
  2. Regularly communicate and provide training for all billers on procedures for recording their time, emphasizing the importance of accurate time tracking and keeping.
  3. Establish policies and procedures as to timeliness of billing, and monitor compliance with these policies.
  4. Establish policies that dictate when and under what circumstances billers are allowed to write down and establish baselines for seeking authorization for write-downs. 
  5. Regularly review write-down in both hours and a percentage of time at the client and firm level.  
  6. Require biller to provide an explanation of the circumstances surrounding any significant write-  downs. 

To Improve Collection Realization:

  1. Establish policies for billers to regularly manage their accounts receivable and hold them accountable.
  2. Review the current payment status of all of your firm’s clients by using an accounts receivable aging report.  
  3. Review aged balances regularly to identify potential collection problems early and focus your efforts on these accounts. 
  4. Communicate with late-paying clients often until a payment is made or a payment plan is established.
  5. Don’t allow clients to manage your cash-flow. Be proactive on collections.

 
Establishing and communicating formal billing procedures that all timekeepers must follow will help your firm maximize its profit and realization potential.  All it takes is some planning and communication to start seeing an improvement on your firm’s realization.  In the end, when it comes to law firm revenue and profitability you need to remember: it’s not what you bill that matters, but what you collect. 

 

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