News
Law Practice
Jul. 25, 2002
Profit Calculations
Dicta Column - By Barbara Lewis and Dan Otto - The average profitability for a law firm should be around 33 percent. After all expenses and taxes are paid, partners should take home one-third of the revenues. Firms' whose profit margins are higher than 33 percent can congratulate themselves. Some efficient firms with smoothly running operations can boast margins of 70 percent or more.
Dicta Column
By Barbara Lewis and Dan Otto
The average profitability for a law firm should be around 33 percent. After all expenses and taxes are paid, partners should take home one-third of the revenues. Firms' whose profit margins are higher than 33 percent can congratulate themselves. Some efficient firms with smoothly running operations can boast margins of 70 percent or more. If your firm's profit margin is less than 33 percent, however, firm leaders should take a closer look at profitability by department.
Not all departments are created equal. Some departments may have high profit margins while others have lower ones. This is especially true for firms with insurance defense practice areas with several types of clients. These departments may only generate a 10 percent profit or even a loss, while the corporate litigation department may have a 40 percent profit. In this case, the firm should concentrate on improving the operations of the insurance defense department, such as by delegating more duties to paraprofessionals and standardizing procedures in order to improve its efficiency.
Often this discrepancy in profit margins among departments is a point of contention with partners who want to split profits evenly even though they are not contributing to the profits equally. As a general rule, partners whose departments are generating high profits should be earning more than partners whose department profits are much less.
Calculating profitability by department, type of client or matter can help firms focus on areas that need improvement. Don't fix the practice areas that aren't broken. Also, tracking the progress of improved profitability by department or type of matters can reveal trends that will show if that area is operating in the best interest of the firm. Firms with unprofitable departments should consider curtailing those departments or shifting resources to more profitable ones.
What are the mechanics of determining profitability by department? For comparison purposes, define department profits by considering only those expenses that can be segregated. The top two expenses for most firms, payroll and rent, generally fall into this category.
Department profits should be defined as revenues minus direct expenses and allocated rent. Revenues should be segregated by department. Direct expenses can include salaries and wages, benefits and client costs only insofar as they can be attributed to that department. Salaries for nondepartmental employees and expenses such as word processing, accounting and marketing personnel, office supplies, insurance, postage, etc. - general and administrative costs that cannot easily be attributed to any specific department - should be ignored for purposes of department profits. Rent should be allocated by the percentage of space taken up by the particular department.
Now compare the departments' profitability. A net loss in any department's profit calculation indicates a serious problem because there is no contribution by that department toward the firm's indirect expenses. Concentrate your improvement efforts on the least profitable departments first. If all departments appear reasonably profitable, then investigate the remaining indirect general and administrative expenses.
Although you may know your firm's overall profitability, calculating profitability by department will enable you to expand more profitable areas and contract or improve less profitable areas. In some cases, firms are willing to forego the profitability of one department because it helps attract business to a profitable department, sometimes known as a "loss leader." However, this should be part of a firm's overall business strategy rather than an accident.
Barbara Lewis and Dan Otto are co-founders of Centurion Consulting Group in Los Angeles, which assists firms with business planning, finance, operations and marketing. They can be reached at www.centurionconsultinglaw.com.
By Barbara Lewis and Dan Otto
The average profitability for a law firm should be around 33 percent. After all expenses and taxes are paid, partners should take home one-third of the revenues. Firms' whose profit margins are higher than 33 percent can congratulate themselves. Some efficient firms with smoothly running operations can boast margins of 70 percent or more. If your firm's profit margin is less than 33 percent, however, firm leaders should take a closer look at profitability by department.
Not all departments are created equal. Some departments may have high profit margins while others have lower ones. This is especially true for firms with insurance defense practice areas with several types of clients. These departments may only generate a 10 percent profit or even a loss, while the corporate litigation department may have a 40 percent profit. In this case, the firm should concentrate on improving the operations of the insurance defense department, such as by delegating more duties to paraprofessionals and standardizing procedures in order to improve its efficiency.
Often this discrepancy in profit margins among departments is a point of contention with partners who want to split profits evenly even though they are not contributing to the profits equally. As a general rule, partners whose departments are generating high profits should be earning more than partners whose department profits are much less.
Calculating profitability by department, type of client or matter can help firms focus on areas that need improvement. Don't fix the practice areas that aren't broken. Also, tracking the progress of improved profitability by department or type of matters can reveal trends that will show if that area is operating in the best interest of the firm. Firms with unprofitable departments should consider curtailing those departments or shifting resources to more profitable ones.
What are the mechanics of determining profitability by department? For comparison purposes, define department profits by considering only those expenses that can be segregated. The top two expenses for most firms, payroll and rent, generally fall into this category.
Department profits should be defined as revenues minus direct expenses and allocated rent. Revenues should be segregated by department. Direct expenses can include salaries and wages, benefits and client costs only insofar as they can be attributed to that department. Salaries for nondepartmental employees and expenses such as word processing, accounting and marketing personnel, office supplies, insurance, postage, etc. - general and administrative costs that cannot easily be attributed to any specific department - should be ignored for purposes of department profits. Rent should be allocated by the percentage of space taken up by the particular department.
Now compare the departments' profitability. A net loss in any department's profit calculation indicates a serious problem because there is no contribution by that department toward the firm's indirect expenses. Concentrate your improvement efforts on the least profitable departments first. If all departments appear reasonably profitable, then investigate the remaining indirect general and administrative expenses.
Although you may know your firm's overall profitability, calculating profitability by department will enable you to expand more profitable areas and contract or improve less profitable areas. In some cases, firms are willing to forego the profitability of one department because it helps attract business to a profitable department, sometimes known as a "loss leader." However, this should be part of a firm's overall business strategy rather than an accident.
Barbara Lewis and Dan Otto are co-founders of Centurion Consulting Group in Los Angeles, which assists firms with business planning, finance, operations and marketing. They can be reached at www.centurionconsultinglaw.com.
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