Measuring and Making Decisions Around Your Firm’s Revenue Capacity
In our previous post on the subject of revenue capacity at your law firm, we looked at calculating the theoretical maximum earnings based on your current situation. That’s your baseline: the revenue your firm can generate over the course of a week, a month, a year, given the current circumstances. In this post, we’ll review an example of how to calculate your baseline now. Going forward, however, you’ll need to do two things reliably in order to make informed decisions. One is measure your current operating level and the second is forecast the impact of adding or subtracting staff or possibly adding alternative fee arrangements to your practice.
Establish your baseline
Let’s begin with another quick example of calculating your baseline revenue capacity. Suppose you are a solo attorney with one paralegal, each capable of billing 40 hours per week. Let’s say your hourly rate is $300 and your paralegal’s is $150. Your firm’s revenue capacity per week is ($300 x 40)+(($150 x 40) = $18,000. That translates into (52 x $18,000) = $936,000 per year in total revenue. That’s your baseline and it’s not a bad one for a small firm with two people billing.
Identifying the Gaps in Law Firm Revenue
Determine your current situation
In order to gain meaningful insight into your functional revenue capacity, you’ll need to measure it frequently by recording your actual performance and comparing it to your baseline. For example, let’s say for the past year, you’ve only been averaging 31 billable hours and your paralegal billed 35. Your actual revenue was ($300 x 31) + ($150×35) = $14,550 per week. This translates to $14,550/$18,000 = 81% of true capacity. Operating at 81% of your revenue capacity may be OK for you. Or, it may be a wake up call.
Calculate profitability level
The next step is to calculate profitability. To truly calculate profitability at the firm level, you must be aware of all of the various costs that are inherently built into operating a law firm. For purposes of this post, we’ll stick with the basics, but there can be many more miscellaneous costs that your accountant and others can help identify. Assume you’ll be faced with a fixed overhead for office space, a salary for your paralegal, utilities and vendor invoices for various services, marketing expenses, travel and court related costs, etc. Assume that these total about $50,000 per month or $600,000 per year.
It’s decision time
Now, looking at the same figures through a different lens, it’s easy to see that one example shows annual profitability of $336,000 per year and the other nets $156,000. The difference? 14 extra billable hours per week. Assuming you are not able, for various reasons, to exceed the current threshold of 31 and 35 hours per week of billable activity, respectively, then maybe it makes sense to consider either hiring another associate or to consider alternate fee arrangements for some clients. According to the most recent 2014 Georgetown Law Survey, published by Thomson Reuters, “29 percent of firm leaders indicated that their firms had changed their strategic approaches to pricing since 2008.” Perhaps they recognized some of the same issues in the struggle to maximize billable hours that your firm encounters.
The bottom line is, profitability fuels growth and law firm growth is fueled by efficient operations. Keeping a sharp eye on revenue capacity and consistently measuring current performance against the optimal situation will let you know how well you’re doing against your ideal baseline.