Financial Errors Every Law Firm Should Avoid

BY STEVE MANEKIN, CPA

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The following article was prepared by its author. The opinions expressed in the article represent the author’s and may not reflect the view and/or opinion of Vallit Advisors and its staff. Views/opinions are based on the specific facts and circumstances of each Matter.

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Steve Manekin is a Managing Director with Vallit Advisors, LLC. Steve is a Certified Public Accountant (CPA) and brings over four decades of experience as a nationally recognized law firm consultant. He has worked with firms of all sizes, helping them optimize performance, improve profitability, and navigate complex business challenges. Mr. Manekin can be reached at 443-482-9500 Ext 116 or smanekin@vallitadvisors.com

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Law firms often face various issues that can result in substantial financial repercussions. This article addresses a “Top 10” list of financial mistakes that law firms often make.

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Introduction

There are many television shows that now have a “Top 10” of something that they feel strongly about. Sometimes these lists can be the highlight of their program. So, since everyone from Moses to Letterman has succeeded with this approach, here is my “Top 10” List of financial mistakes that law firms often make.

Here is the list in a traditional Top 10 order:

1. Failing to manage your malpractice risk
2. Failing to assign the responsibility to manage costs
3. Failure to communicate and require that each partner plan for his or her retirement
4. Failure to properly reward partners for their business development efforts
5. Failure to develop a long-term strategy for the firm
6. Failure to even investigate potential alternative billing ideas
7. Failure to review partner compensation on a consistent basis
8. Failure to develop long-term technology plans
9. Failure to properly capitalize the law firm
10. Failure to micromanage the billing and collection timeline
11. 1a. Failure to develop a plan to build a strong firm culture/work environment for your firm

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“Top 10” List of Financial Mistakes

 

10 — Failing to Manage Your Malpractice Risk

Lawyers are the best people to understand that we live in a litigious world. The cost of a malpractice case can be debilitating for a firm, not only monetarily but emotionally and professionally. To guard against this, the firm should give high priority to its quality control systems. Another idea is to appoint one of the partners as the Risk Management Partner whose responsibility is to manage the firm’s quality controls to reduce the risk.

 

9 — Failing to Assign the Responsibility to Manage Costs

Someone such as a professional firm administrator, executive director or Chief Financial Officer (“CFO”) should be assigned the responsibility of managing costs. Another thought is that these folks would report up to the managing partner or administrative partner. The overwhelming majority of well-managed firms prepare yearly budgets to help control costs and profitability. Using a well-prepared budget to manage costs is a must. Remember that the budget is a living document and should be updated during the year.

 

8 — Failure to Communicate and Require That Each Partner Plan for His or Her Retirement

The days of big buyouts for retiring partners are over. Any partner that believes the firm will provide for his or her retirement out of current operations is being unrealistic. The firm can help by adopting qualified retirement plans. It is up to each partner to adopt an individual retirement plan and fund at least part of it with after-tax dollars.

 

7 — Failure to Properly Reward Partners for Their Business Development Efforts

Firms that do not properly reward business development will have a hard time surviving. Business development includes expanding work to current clients as well as bringing in new clients. Additional rewards should be available for a partner or associate who consistently develops new business, referral sources, develops new service offerings, etc. Anything done to enhance the reputation of the firm should be rewarded. As the old saying goes, “nothing happens until the cash register rings.”

 

6 — Failure to Develop a Long-Term Strategy for the Firm

You can’t get where you want to go without a plan or strategy to get there. This strategy should include both long-term and short-term goals. Those strategies along with budgets (i.e., revenues, billable hours, expenses, capital expenditures, etc.) are imperative for a firm’s life cycle. To begin the process firms should consider having strategic planning retreats/meetings to proactively plot the course of the firm into the future.

 

5 — Failure to Even Investigate Potential Alternative Billing Ideas

The legal market, as with any professional service industry, has always been very competitive. Clients are demanding better options for paying for their legal services. Firms must be ready to find creative ways to bill their clients beyond an hourly basis. Each matter could be looked at to see if there is a better way to bill the client. Some firms employ a Client Billing Specialist for just this issue. Encourage your client to see you as an asset and not a cost. If you are not doing this now your competition can easily steal your clients.

 

4 — Failure to Review Partner Compensation on a Consistent Basis

Law firms can no longer claim to be bastions of stability. The lateral and merger market have turned lawyers into free agents. If firms do not consistently review their compensation systems, they will consistently lose talent to their competitors. Each partner needs to be realistic about their contribution and accurately perceive how much they are respected by the other partners. Whatever compensation system your firm uses, the perception is that it must be fair. If the method reflects the mission and the plan of the firm and is clearly communicated to the partners, then stability and enhanced profitability should be the result.

 

3 — Failure to Develop Long-Term Technology Plans

With the advent of artificial intelligence (“AI”) and other new technologies, firms that do not plan for changes and upgrades to their systems will either fail or be overtaken by better-prepared firms. With enhanced competition, firms must be able to offer faster and more cost-efficient legal services. The use of the appropriate upgraded technology will enable the firm to provide better quality services at a lower price.

 

2 — Failure to Properly Capitalize the Law Firm (and Maintain Cash Reserves)

For your firm to be able to withstand any financial storm it needs to be built on a strong financial (capital) foundation. Firm capital is not a black and white issue. Each firm has different needs and plans. For instance, a contingent-based firm should be well-capitalized due to the costs they have to pay out — the partners, a bank or litigation financing companies fund case costs. How much capital is enough depends on the following factors:

• Practice areas
• Timeliness of billing and collections (i.e., bankruptcy or estate/trust practices)
• Size of partner draws (never borrow to pay partner draws!)
• Age of the firm
• Technology requirements

Partners not funding their firm properly will have a new partner and that will be the bank. Firms should retain enough capital to be liquid throughout the peaks and valleys of the cash operating cycle. A rule of thumb is to have 1–3 months of working capital on hand.

 

1 — Failure to Micromanage the Billing and Collection Timeline

Without proper cash flow, firms are doomed to a lifetime having a bank as a partner or worse, failure. To ensure the firm has proper controls over its billing and collection systems it should consider the following:

• Create a total understanding of the work to be done and the billing policies of the firm in an engagement letter
• Require retainers when possible
• Request that the client pays for cost advances
• Make sure your bills are easy to understand, and you address them to the individual paying the bills
• Require all bills to go out by a certain date (the faster the bills go out, the faster the cash comes in)
• Monitor your accounts receivable and work-in-process aging carefully
• Call the client the day the bills are past due
• Monitor your realization and utilization statistics carefully
• Apply service charges on past due invoices
• Create a collection timeline for partners and billing staff to follow

 

1a — Failure to Develop a Plan to Build a Strong Firm Culture/Work Environment

With the different work ethics of the “younger” generations and with the effects still lingering from the COVID-19 pandemic, providing a good work environment is a good way to retain your employees. Part of that work environment includes the partners’ interaction with their employees. Partners that show they care and plan firm functions create a good work environment. Creating this environment will hopefully increase the ability to retain your employees.

 

Conclusion

The above are just 11 of the mistakes that lawyers confront today. For your firm to survive you must confront these and other issues head-on. If time constraints do not allow you to address these issues, consider engaging a consultant to help with any education of your partners/staff and implementation of any new plans.