Law Firm Profitability Metrics Every Lawyer Should Know
Whether you plan to start a new law firm or restructure an already existing one, profitability analysis can be a huge challenge. For example, it may be difficult to decide between billing per hour and charging a flat fee. Also, there’s always the question of whether you’re charging too much or too little for your services.
The good news is that you don’t have to be a financial wizard to figure out your firm’s profitability metrics. These tips will help you make the right decision for your law firm’s profitability by calculating and converting your time and productivity into the money you deserve.
5 Steps For Pricing Your Legal Services
Pricing your legal services is crucial to your law firm’s profitability. Typically, it communicates a lot about the quality of your services to your clients and determines whether they’ll hire you. Unfortunately, many law firms still struggle to find the most appropriate price tag for services they offer and are never sure whether their prices attract or repel potential clients.
Here’s what to consider when coming up with prices for your legal services:
You need to start thinking of your services as a product. For example, consultation for legal advice and client representation are two different products. Additionally, you’ll need to identify your niche for clients to understand the kind of services to expect from you. Eventually, you can decide to group the services differently and attach the fees for each package.
The revenue model is determined by the firm’s operational requirements and market demands. These two factors play an important role in choosing the firm’s business model and cash flow structure.
For instance, if the firm is often busy and incurs huge operational costs daily, it’ll require a steady cash flow to sustain its operations. With that in mind, it’s easier to determine whether to bill per hour, have a flat fee, or charge contingency fees.
Additionally, it’s important to note that client cases vary, and a single revenue model may not suit all cases. Clients may also have their own preferences that may determine if they should hire a firm’s services. However you choose to bill, it’s important to use a proper legal case management solution (such as Rocket Matter) that can support these different billing options.
Step #3: Consider Your Customer Acquisition Costs
The growth of a business depends on the conversion rate of its marketing strategies. Similarly, a law firm makes profits from the number of customers served. This means that the firm has to adopt a marketing strategy and assess how well the strategy sends valuable traffic back to the firm. Therefore, the Customer Acquisition Costs shouldn’t exceed the profits generated by the clients acquired.
Step #4: Determine Your Case Value and Customer Lifetime Value
The Customer Lifetime Value (LTV) is the business value a customer brings to the firm over their lifetime as a client. This metric is important because it helps identify cost-effective strategies for maintaining existing customers and acquiring new ones.
Calculating a client’s LTV also helps assess whether the revenue model used to bill the client is profitable over the lifetime. For example, a flat fee per case may not fetch the same revenue as hourly billing over a client’s lifetime. However, the two revenue models may not be interchangeable between different products a firm offers, but their LTV will help the firm decide on which product and market to focus on.
Step #5: Understand Your Fixed Costs
The firm’s expenses also impact the general profitability metrics. These expenses are often described as operational costs and may include office rent, technology costs, and support staff salaries. After all, the net profit of a business is the difference between its revenues and expenses.
A business that masters how to reduce operational costs without straining or compromising the quality of its services will always record higher profits. The same case applies to a law firm.
For more information on reducing operational costs, see: How to Reduce Your Law Firm’s Overhead Costs and Still Be Productive
Cracking The Numbers
The real number cracking begins after outlining all the factors mentioned in the guide above. The first metric to calculate to help with your law firm profitability is the Customer Acquisition Costs (CAC) which determines the total cost of serving clients, including advertising and marketing costs. Most importantly, customer acquisition costs should convert to clients who ultimately bring in money into the firm.
The Customer Acquisition Cost then converts into the Lifetime Value of each customer acquired. Basically, you can find out if the CAC converts into the intended profitability of the firm in both long-term and short-term projections.
Client LVT is determined by the difference between the revenue and labor cost to determine the profit margin. Depending on the number of transactions between the customer and the firm, the profit margin projects how much profit the firm will make from one client.
Finally, the firm keeps the net profits it attains after deducting all its operating expenses.
Interpreting The Numbers
Each of the metrics calculated has an impact on the profitability of the firm. The figures help strategize the business activities and point out the key performance indicators to increase profits.
Here’s how to interpret these numbers.
The CAC recouping rate determines how fast the business regains the customer acquisition costs while serving the client. This rate derives from the CAC and profits per transaction (per case or service).
The most desirable recouping rate is characterized by a shorter recovery period. If the firm takes too long to recover its costs, it may need to restrategize its target market.
Every business would like to have a strong ROI (return on investment), especially over the long-term period. For example, the ROI in a law firm derives from dividing the Client Lifetime Value and the Customer Acquisition Cost.
A strong ROI means that the business excels in acquiring more clients. It’s also possible to rank the type of clients that convert into the strongest ROIs. As a result, future CAC investments would target such clients to improve on the firm’s ROI.
In general, these law firm profitability metrics provide a clearer picture of the firm’s variables such as profit margins, income before tax, annual revenue, direct costs, number of clients or cases per year, and so forth. Thus, such figures are essential for proper business planning, reporting, and even abiding with tax compliance and certification requirements.
Law Firm Profitability- The Bottom Line
A law firm’s profitability depends on Customer Acquisition Costs and Customer Lifetime Value. These two metrics determine how well the law firm survives the industry’s different challenges to obtain a longer-lasting market presence. Without them, the business may not be able to sustain itself long enough over a few years.
Looking to run a more profitable law firm? Take the first step with Rocket Matter’s best-of-breed legal practice management system. Schedule a personalized demo today to see it in action!