Is 2023 going to be a profitable year? Key Metrics to Track
Part One: Law Firms Are Profitable. Is your firm?
Let’s set the stage with a very positive image: Law firm businesses are very profitable businesses. According to an IBISWorld article in 2022, law firms ranked in the Top 10 most profitable industries, seeing a 1.5% increase in revenue and projecting total profit for 2022 at $78.7B. So, yes, you can make money running a small law firm! That doesn’t mean it’s easy to do, but with the right tools in place, at least you will know if you are being profitable.
Fall has arrived, the weather is changing, the festivities for the rest of the year are being planned, and—just when you get a chance to take a deep post-holiday breath, it’s going to be January. You sit down to reconcile your bank accounts for December’s activity, also reviewing last year’s revenue/expenses, an exercise you do (should be doing) every month. So long as there’s money in the checking account, life must be good – right? Maybe, but it begs the question – “Was your business profitable in 2022, and can it be doing better?”
January is a great time to take a step back from your business and commit time to reviewing the financial health of your business. To close out 2022, we will focus our blogs on key metrics to track for profitability.
- Reports you should have in place and be reviewing to help you better understand the financials of your firm.
- Key metrics to reveal weaknesses in your business. Or identify strengths and give yourself a pat on the back. Celebrating success is important!
Preparing for 2023: Reports for Reviewing Money In, Money Out
Here are a few reports we like to use near year end to examine revenue and expenses:
This is an area where you can have a true heart-to-heart discussion with yourself. This is money left on the table and your Budget vs. Actual report will absolutely show if you are not collecting what you thought.
Use this report to identify where you maybe mismanaged cases, hired a client that was not a good match, and communication about past due bills was not consistent. Are you billing consistently so clients are getting regular communication? (Check out our article here on Streamlining Billing to Increase Revenue). Also, are your invoices easy to understand? Are you using payment plans? There are a lot of good questions to ask yourself and help you plan for a better 2023 when it comes to Accounts Receivable.
Profit and Loss Reports:
The profit and loss (P&L) report is a financial statement that summarizes the income/revenues, advanced client costs (and other cost of goods sold), and expenses incurred during a specified period. The P&L is one of three financial statements that every law firm should be producing and reviewing monthly, along with the balance sheet and the cash flow statement.
A YTD profit and loss report that shows expenses as a % of income. Payroll and marketing are expenses that should have the highest % of income. Rent might be up there as well, but after the last few years, we have all adapted to working from home which may have cut this expense for your firm.
What else does a P&L show you? You should be reviewing this report as a part of your monthly financial packet either you or your bookkeeper produces.
- When used together, the P&L statement, balance sheet, and cash flow statement provide an in-depth look at your financial performance.
- It is also important to compare P&L statements from different years, as any changes over time become more meaningful than the numbers themselves.
Budget vs Actual Report or Your Financial Plan (because everyone hates budgets):
Review your budget vs actual report. If set up correctly, this report has been tracking income and expenses by month. This report provides a birds’ eye view of how you made and spent money and compares it to your budget. This report is a great tool that tells you if you are still on track. This data will help you see if you are good a budgeter and also help create next year’s budget.
Key notes on Budget vs Actual reports:
- This is a work in process and should be reviewed and updated each month as our business changes throughout the year.
- Your Budget vs. Actual report is your P&L sitting next to your Budget Report. Be sure to look at it showing a column for each month.
- At the bottom of the report, did you make money this year?
- Look at was your revenue over or under budget.
- Did you split your income by practice area? If so, what practice areas were over or under?
- Ask yourself if marketing spends during the year affected any of these numbers.
- Look at expenses:
- Where did you overspend? Maybe the extra expenditures are justified.
- What accounts never had expenses applied to them? This would be for two reasons:
- Did you create expense categories that were never utilized? If so, delete those categories to declutter the report.
- Have you allocated expenses to the wrong accounts? Reviewing and fixing allocation will give you a true picture of actual expenses.
QUESTION: Does your budgeted income number reflect your collection realization rate? If you budget to bill 1500 hours/year at $200/hour, your budgeted revenue is $300,000. But it’s not a perfect world and this is not what will be collected. Knowing your collection realization rates will help you set a realistic revenue number to drive your budget.
By the way, QuickBooks has a great tool to build your budget and use in your monthly reporting.
Other Data to Gather & Review:
- Reports to review your cases:
- Identify referral sources.
- Did these referred clients turn out to be great clients or problem clients?
- If you are doing flat fee billing, analysis flat fee cases for profitability. It may be time to raise flat fee rates.
- Identify referral sources.
- Know your monthly nut. If you have not spent the time to create this number, do it now. It is important to know how much you need to collect each month to cover your fixed monthly expenses.
Flat Fee Cases.
If you do flat fee cases, do you know how profitable you are on these cases? If you have not been tracking this information, you may now see why this is important to track, looking at the below chart. The New Year provides you a wonderful chance to raise your rates. CPN Legal can help complete a flat fee analysis for your cases. Give us a call to find out more.
Stay tuned for Part Two, where we’ll breakdown 6 key metrics you should be tracking. Measuring progress is crucial and you can’t do that without good data.