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How to Use Aged A/R Reports

Firms of all sizes fail because they do not pay attention to collections. While recording hours and billings are important, cash flow is mission critical to all businesses. In this third installment of our five-part series, we shift from client development to examine a collections KPI that will drive improvements to your administrative processes.

Most firms pay staff and their bills on a regular cycle, usually within 30 days. Therefore, you must collect from clients at least within the same time frame. Otherwise, the firm will be forced to borrow money or dip into reserves. We use an aging tolerance for clients’ monies owing or accounts receivable (A/R) to monitor collections.

Most legal practice management systems and all accounting software create an aged A/R listing. This report shows how much is outstanding currently and over thirty, sixty, ninety, and one hundred and twenty days.

Using the example above from my small law KPI book, the PI firm has billed out $495,000 in January and their target is to collect all but 10% of that within the next 30 days. In other words, at any given time, only 10% of the money owed by clients should be outstanding for over thirty days. This target would be created based on the amount of cash flow needed to pay the bills. The A/R greater than 30 days of $104,688, or 21% of the monthly billing of $495K, is cash that is not accessible to pay the PI firm’s bills.

With this result, this PI firm can do the following:

  • Review prior months to see if there is a trend or if this is an anomaly;
  • Investigate the $104,688 to review if there are one or two large amounts or many small amounts and try to see if there is pattern;
  • Follow-up on the A/R over 30 days weekly by contacting the clients;
  • Analyze the days that time remains unbilled as perhaps the bills are stale by the time they reach clients; and
  • Accept payment online and use retainers where possible.

Many small firms just look to the bank balance to see if they are okay. However, it’s too late to make changes if you wait to see how the month turns out. An aged A/R listing can help firms keep better track of their cash flow.

Originally published 2017-03-30. Republished 2019-12-19.

Rethinking Law-Firm Productivity Measurement for the Post Billable Hour Era

The traditional definition of “productivity” in law firms is seriously messed up. A few days before I sat down to write this piece, Joshua Lenon of Clio made the case much better than I could in a brief tweet storm on Twitter.

The [2018 Report on the State of the Legal Market by Georgetown Law School and Thomson Reuters Peer Monitor] defines “law firm productivity” as “the number of billable hours worked by lawyers divided by the total number of lawyers.” Productivity in business is units of output divided by unit of inputs. Peer Monitor seems to think that lawyers’ hours are outputs, and the number of people working are the inputs.

Ask any client what they purchased from a law firm. I would be shocked if any client responded that they purchased the production of lawyers churning time. Clients purchase value, certainty, and guidance. That may be a merger agreement, securities documentation, litigation labor. Clients purchase outcomes, not hours.

This definition of productivity…wrongly assumes law firm partners are the end customers in the legal profession, and not our clients. Lawyers, your value to clients is not what you bill. Your productivity should not be measured in hours, but in outcomes.

I have some additional thoughts about how we got to this point—and why we probably won’t, unfortunately, be leaving it anytime soon.

The Peer Monitor-style definition of “productivity” in law firms is clearly inane. Suppose I take ten hours to complete a task as a first-year lawyer. By the time I reach my second year, I’ve gotten better at my job, and I can do the task in five hours. By any traditional measure, I’ve doubled my productivity. By a law firm’s measure, I’ve reduced it by half. That can’t be right. So what’s going on here?

The problem is that in traditional definitions of productivity—units of output divided by units of input—the units of output are the same for both seller and buyer. The seller produces planks of lumber, and the customer buys planks of lumber and takes them home. Same with heads of lettuce, iPhones, whatever. The seller’s output and the customer’s outcome are pretty much identical.

Clients, as Joshua Lenon says, consider the outcomes they achieve to be the “output” of the law firms they hire. The firms, however, consider their “output” to be not client outcomes, but the effort produced to generate those outcomes. A law firm doesn’t charge clients for accomplishing a task, it charges them for the number of hours it took their lawyers to do that task.

Law firms aren’t doing this to be evil or obtuse. They’re doing it because they’re using lawyer hours as a proxy for client outcomes. And clients have felt obliged to accept that state of affairs because clients and law firms can’t work together if they believe that “output” means two different things. They would then be working towards two different goals. So what has traditionally occurred in the legal market is that clients have accepted the law firm’s proxy substitution of lawyer hours for client outcome: They’ve effectively agreed, by signing a check, that the law firm’s output is its effort.

The client might feel like saying, “I’m not paying you for your time, I’m paying you to create a shareholders’ agreement.” The law firm (implicitly) says, “We don’t know how much to charge you for a shareholders’ agreement because we don’t know its value, and, frankly, neither do you. So we’re going to use the hours our lawyers spent to produce that agreement as a substitute measure of its value. Our effort generated your outcome; for business purposes, we deem that our effort is your outcome.”

Many clients, reasonably enough, want to change that. They want to be charged on the basis of the value of the task that the law firm has performed for them, not the law firm’s hourly proxy. They believe that if law firms did this, the firms would no longer consider a reduction in hours to be a reduction in productivity; firms would welcome increased efficiency and fewer hours because lawyers would be making money based on client outcome, not lawyer effort. It’s a win-win, right?

Here’s the problem: The law firm doesn’t know what its services are worth to its clients. In most cases, neither does the client. I don’t want to rehash the whole debate over value pricing versus market pricing, but unless client and law firm can agree on the value of the firm’s service to the client and set a fixed price, then law firms will continue to use hours as a proxy for value, and they will not adopt the business world’s definition of productivity.

Law firms sell hours. That’s what they track, record, and place on their bills, and that’s what clients pay them for, even if they’d rather not. Law firms use hours as a proxy measure for client outcomes, and clients accept this because they implicitly recognize that they need a shared understanding of outcomes and most of them don’t have a better one to offer.

Using billable hours as a proxy for client value is stupid. But it’s also quicker, more understandable, and more convenient than any other system yet proposed, and that’s why we’re still using it.

How to Calculate Client Acquisition Cost

Measurements and metrics are important at every step of the firm workflow, even during client development. Other than the unique ethical advertising considerations applicable to lawyers, we can borrow from small business development practices and technology. In the second of this five-part series on key performance indicators (KPIs), we’ll examine the calculations for client acquisition cost (CAC) to answer the question of how much is spent before the client’s matter begins.

Using the figures below, the IP firm has spent almost three thousand dollars attracting one client in the month of January. Whether that result is good or bad depends on the potential revenue from the matter. However, the IP firm has set a target of $250 per client, so being over ten times the target requires further analysis.

In addition, the $2,950 CAC result is a problem if the revenue from the client does not significantly exceed that $3,000 to allow the firm to make a profit. In other words, the firm may spend more to acquire and deliver services than the revenue they will see from the case. This will negatively impact the firm’s bottom line profits.

Looking at January’s costs for client acquisition, the IP firm spent $450 on advertising, sales, and marketing costs as reported by the accounting system. For the same month, the attorneys tracked the non-billable time spent with potential clients in free one-hour consultations. Those ten hours, at an average of $250 per hour, result in $2500 of time spent on client development and must be included in the CAC.

Some might challenge those hours by saying that the attorneys and associates are not being paid a salary of $250 for those ten hours. However, the attorneys are not able to bill for those hours, and therefore the true opportunity lost or cost is $2500, not the salary earned.

Results like this bring up questions around process and the use of technology. For example, this IP firm could use a questionnaire, like Traklight’s product for IP, to gather information or triage clients at a fraction of the cost of an attorney hour. Further, the firm could provide thirty-minute consultations to only those clients with IP legal needs and consider charging a reduced rate for those meetings. Not only would that improve the conversion rate by pre-qualifying clients, but the CAC would be significantly reduced.

KPIs are truly the starting point for streamlining your practice and improving your bottom line and it is important to consider measures that directly impact the firm’s cash balance.

If you would like assistance figuring out how to calculate your CAC and see the other KPIs in this series, here’s a free spreadsheet to get you started.

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