Law firms have a reputation for being slow to adapt to change. But the reality is that successful law firms are adopting data-driven metrics to drive their business strategy and improve profitability. The five metrics below can help you understand the health of your law firm finances and make it easier to spot opportunities for improvement.
Loss ratio
One of the most important metrics to track is your loss ratio. The loss ratio is a simple calculation that displays how much money you lose on your cases compared to how much money you bring in.
To calculate the loss ratio, take the amount of money lost by clients and divide it by total revenues. If you have $10,000 worth of unpaid bills and only bring in $5,000 per month, then your first step should be improving collections—because this means 50% of all incoming funds are going out as losses.
The ideal loss ratio is anywhere between 20%-40%. This doesn’t mean all clients will pay their bills on time; some may dispute charges later down the line or fail to appear for court dates due to illness or other scheduling conflicts. In these situations where a client does not pay his or her bill within 30 days after invoicing (or whatever time frame works best), this is when their account becomes delinquent and must be written off as uncollectible.
Overhead expense ratio
The overhead expense ratio is the percentage of overhead expenses compared to total revenue. You can use this metric to compare your firm’s overhead expenses to other firms in your industry and as a benchmark for comparing how much you spend on overhead over time.
If you’re starting a law firm or looking for ways to cut costs, this measurement can help you determine whether your current spending on office space, insurance policies, and utilities are necessary or excessive. For example, a law firm that spends 25% of its revenue on overhead costs might decide it needs a less expensive office space if it has no clients who are willing to travel more than 100 miles from home. The data should also give insight into whether there are any unused services or equipment that could be scaled back without affecting service quality.
Profit factor
The profit factor is a metric that measures the ability of a firm to generate profits. It’s calculated by dividing net fee income by total expenses. This metric reveals whether or not your firm is making money and, if so, how much. A high-profit factor indicates that you are earning enough money to cover all of your operating costs, including rent and payroll—and then some. A low-profit factor suggests that something is amiss; perhaps you need more clients or better pricing.
Fee income revenue for partners
Fee income revenue for partners is a percentage of the total fees earned by the firm. It is calculated by dividing the total fee income by the number of partners. The formula looks like this:
Fee Income Revenue = Total Fees Earned/Number of Partners
A high percentage in this metric indicates that your firm is profitable, and a low percentage may mean that it’s losing money or barely breaking even.
Net cash flow
Net cash flow is a metric that measures the amount of cash a business generates after deducting all expenses and investments. In short, this metric shows how much money your firm has been able to generate after paying off its expenses and investing back into itself. In other words, it tells you whether or not you’re making money—and if so, how much.
Conclusion
The metrics listed above provide a good starting point for law firm financial analysis. However, each law firm is different and will have unique needs that must be considered when choosing which metrics to analyze.
