Improving your financial health
Mac Mackay
In finance there are a number of different factors to consider
While the purpose of many a law firm would be defined in some form of profitability objective what is management’s role in finance? Over half a century ago, Peter Drucker wrote: “Management must always, in every decision and action, put economic performance first. It can only justify its existence and its authority by the economic result it produces”.
In his case, when Drucker said ‘economic performance’ he was talking not only about profitability, but the maintenance or improvement of the “wealth-producing capacity of economic resources” in the business.
Maximising profits was not, for him, the main goal of management – for him, profit was the result, not the aim.
As said, profit is what is left over from fee income after all the firm’s expenses have been paid and to increase profit a manager must maximise revenue or minimise expenses – or both. So far, so obvious!
In a partnership, however, the ultimate measure of profitability is (or should be) profit per partner, which is driven by three main factors, margin, productivity, and leverage.
Profit per Partner
- Cash-flow (the ability to pay your bills when they fall due) determines your likelihood of survival
- Profit (what’s left from income after paying for expenses) shows your success.
- Profit growth over time (next year compared to this) determines how the firm is prospering.
While the purpose of many a law firm would be defined in some form of profitability objective what is management’s role in finance? Over half a century ago, Peter Drucker wrote: “Management must always, in every decision and action, put economic performance first. It can only justify its existence and its authority by the economic result it produces”.
In his case, when Drucker said ‘economic performance’ he was talking not only about profitability, but the maintenance or improvement of the “wealth-producing capacity of economic resources” in the business.
Maximising profits was not, for him, the main goal of management – for him, profit was the result, not the aim.
As said, profit is what is left over from fee income after all the firm’s expenses have been paid and to increase profit a manager must maximise revenue or minimise expenses – or both. So far, so obvious!
In a partnership, however, the ultimate measure of profitability is (or should be) profit per partner, which is driven by three main factors, margin, productivity, and leverage.
Profit per Partner
[1] Adapted from Maister, D. H. Managing the Professional Service Firm, (1993) Free Press – chapter 3
In managing a professional firm, as with any business with multiple products or service lines, or multiple locations, it is a mistake to place too much stress on one of these three sub-factors (margin, productivity, or leverage). Different operating units can and do achieve high profit per partner in different ways. Some offices, practice units, or even individual partners, will achieve it by being in high margin businesses, perhaps with modest leverage. Alternately, another office, practice unit, or partner may achieve an equally high profit per partner with thin margins and modest productivity but high leverage.
Unfortunately, in many firms, the reporting systems do not provide equitably for these varying paths to profitability. For example, charge-ability and realization reports are circulated more frequently and more broadly than reports showing how well partners leverage themselves. Consequently, an individual partner who fails to leverage him or herself but has high personal chargeability and high realization (i.e. good productivity) will show up ‘better’ in the firm’s reporting systems than one who is less personally chargeable and commands a lower hourly fee, but keeps five juniors busy. However, the leveraged partner’s activities may ‘throw off’ more cash into partnership profits than the un-leveraged partner.
Rather than establish firm-wide goals for margins, productivity, or leverage, firms should hold each practice (or partner) accountable for a profit per partner target and let the practice (or partner) figure out the best mixture of margin, productivity, and leverage necessary to achieve this goal.
This simple prescription is not commonly followed in professional firms today. Few use net profit per partner as their main method for regular reporting of practice economics. Yet it is only by understanding the profit per partner of different practices, services (and even engagements) that the firm can manage its ‘equity investments’ (partner time) wisely.
Health and Hygiene
The reason so many firms have control systems that emphasize only parts of the profitability formula is that their control systems are designed to focus on short-term profitability (what may be termed ‘hygiene’), and ignore the issue of ‘health’ (i.e., increasing the fundamental profit potential of the organization).
‘Hygiene’ is a day-by-day activity to ensure there are no basic functions being ignored – like good time recording or getting bills paid. These will have an immediate impact and achieve a given ‘standard’ to the firm. Once you have done this, another round of the same activity will not increase your profits much further – you’ll have diminishing returns. Obviously, showering three times a day will not turn you into an Olympic athlete: you will have to do something else to improve your health in the long term.
‘Health’ improvement will require you to improve your diet and get down to the gym (workout). It is the same for your firm. You might have to stop spending time on less profitable clients and invest in higher value services (spend some money on marketing and on training). And the more you do this, the more your health improves.
To test this for your firm, in Figure 2 is a list of possible profitability improvement tactics for a professional service firm. Some will have quick (hygiene) impact while others will have a permanent (health) impact
Profitability Quiz
You are asked to rate the items on this list in three ways. First, rank the items from 1 to 10 according to which action will have the quickest impact on profiability growth. Then rank the items according to which will have the most permanent long-lasting impact on profitability growth. Finally, for each item, rank your firm's performance on a scale of 1 to 5.
(5 = we've really got this one under control, 4 = we do well on this, 3 = we need to improve, 2 = we're weak at this, 1 = we're not working on this)
Only 10 options are provided - contact the author for the full list of 20 or so improvement options.
Unfortunately, in many firms, the reporting systems do not provide equitably for these varying paths to profitability. For example, charge-ability and realization reports are circulated more frequently and more broadly than reports showing how well partners leverage themselves. Consequently, an individual partner who fails to leverage him or herself but has high personal chargeability and high realization (i.e. good productivity) will show up ‘better’ in the firm’s reporting systems than one who is less personally chargeable and commands a lower hourly fee, but keeps five juniors busy. However, the leveraged partner’s activities may ‘throw off’ more cash into partnership profits than the un-leveraged partner.
Rather than establish firm-wide goals for margins, productivity, or leverage, firms should hold each practice (or partner) accountable for a profit per partner target and let the practice (or partner) figure out the best mixture of margin, productivity, and leverage necessary to achieve this goal.
This simple prescription is not commonly followed in professional firms today. Few use net profit per partner as their main method for regular reporting of practice economics. Yet it is only by understanding the profit per partner of different practices, services (and even engagements) that the firm can manage its ‘equity investments’ (partner time) wisely.
Health and Hygiene
The reason so many firms have control systems that emphasize only parts of the profitability formula is that their control systems are designed to focus on short-term profitability (what may be termed ‘hygiene’), and ignore the issue of ‘health’ (i.e., increasing the fundamental profit potential of the organization).
‘Hygiene’ is a day-by-day activity to ensure there are no basic functions being ignored – like good time recording or getting bills paid. These will have an immediate impact and achieve a given ‘standard’ to the firm. Once you have done this, another round of the same activity will not increase your profits much further – you’ll have diminishing returns. Obviously, showering three times a day will not turn you into an Olympic athlete: you will have to do something else to improve your health in the long term.
‘Health’ improvement will require you to improve your diet and get down to the gym (workout). It is the same for your firm. You might have to stop spending time on less profitable clients and invest in higher value services (spend some money on marketing and on training). And the more you do this, the more your health improves.
To test this for your firm, in Figure 2 is a list of possible profitability improvement tactics for a professional service firm. Some will have quick (hygiene) impact while others will have a permanent (health) impact
Profitability Quiz
You are asked to rate the items on this list in three ways. First, rank the items from 1 to 10 according to which action will have the quickest impact on profiability growth. Then rank the items according to which will have the most permanent long-lasting impact on profitability growth. Finally, for each item, rank your firm's performance on a scale of 1 to 5.
(5 = we've really got this one under control, 4 = we do well on this, 3 = we need to improve, 2 = we're weak at this, 1 = we're not working on this)
Only 10 options are provided - contact the author for the full list of 20 or so improvement options.
|
Rank for Quick (Hygiene) Impact
1-5 |
Rank for Permanent (Health) Impact
1-5 |
Rank Your Firm's Performance
1-5 |
|
