Knowledge of Industry Trends Can Be a Powerful Decision Support Tool
Gaining access to industry-wide data helps law firms measure their performance and profitability. With over 25 years of experience in the legal industry, Intelliteach has helped hundreds of firms understand the trends affecting their bottom line. We provide data that is otherwise difficult to obtain.
For this article, we assessed billing information provided by a large group of firms and clients through our Benchmarking and Business Intelligence reports. Every month we receive over a billion rows of transaction data which we process for law firms through our iRIS i3 Data Warehouse. Mining this data, we unearth trends that all firms can use to guide them through the coming months.
Working closely with our clients, we saw that the soft demand for legal work in 2012 caused many firms to fall short of their budgets. We expect to see a continuation of the soft market and suspect that many more firms will fall short of their budgets. Many will fail to match their previous year’s revenue performance.
We see that most firms have some plan to address the older A/R. However, for many it remains their primary cash flow problem. Much of the firms’ profits are tied up in aged A/R.
Even though some law firms excel in this area, the majority are carrying more WIP and A/R than ever before. We are also seeing greater losses in Billing Realization and Collections Realization over the last two years compared to earlier years. The average ages of WIP and A/R continue to increase.
As expected, firms are still looking to control costs. A typical firm’s expenses in this area break down as shown below:
Estimate of Law Firm Back-Office Expenditures
- Our data shows that law firms spend just over 11% of revenue on non-secretarial & non-occupancy staff functions.
- For a firm with revenue per lawyer of $500k, that is over $50k per lawyer on the back office.
- Finance, Administration & Office and Information Technology represent 69% of total spend.
While necessary, cost cutting is not enough to offset market conditions according to most firms. To have a deeper impact on firm profitability, we have to look into the past in order to change the future. We have to examine what was worked, what was billed, and what was collected. If we can interpret the trends behind these actions, firms can begin to realize more profits from the work they have performed.
Bill Rate Comparison
Even in this tight economy, hourly rates have managed to gently rise. Notice that overall realization performance for Worked Rate vs. Collected Rate has fallen off slightly over the past three years. 2012 saw an average loss of $49 per hour from Worked Rate to Collected Rate.
As a percentage, this loss does not represent much change over the last few years. However, losing $49 on every hour worked is a trend that needs to be reversed. To give perspective to this number, the firms used in our poll generated an average of over 340,000 worked-hours last year.
Industry Billing Realization
Billing realization is somewhat dependent on the type of law that is practiced. What is universal is that billing realization decreases over time. So for every dollar billed sooner rather than later, the firm will realize more of its value.
Our real world experience demonstrates that many firms still do not regulate this function as well as they should. Some firms do not require daily tracking of time. This can allow for unintended losses in billing and the impact can be significant. If a firm with 50 timekeepers experiences even an hour per week loss across their billers due to lax policies, this could mean nearly $1 million in lost productivity. (50 timekeepers x 52 weeks x $380 average hourly rate, equals $988,000).
The same degradation applies when billers don’t release time to be invoiced as quickly as possible. For each $1,000,000 that is allowed to reach 120 days of age, only $554,000 will be invoiced. As you can see in the industry average graph above, there is nearly a 14% drop in realization on items billed at 60 days vs. at 30 days.
Industry Days of Unbilled Time
Calculate this for your own firm. Take the last 12 months’ worth of billing and divide that by 365. Take that number and divide it into the amount you have in WIP today. The number you come up with is the Days of Unbilled for your firm for the current month.
Industry Days of Unbilled Time By Size
Small firms excel at billing quickly (days of unbilled), as well as getting high billing realization. The universal rule is that the longer it takes to convert worked time into an invoice, the less value you will receive.
Recovery Performance Against Billed Hours
Across the industry, firms continue to experience an increase in the time it takes to get payments from clients. The chart above shows a 5-year history of Recovery Rates and related performance indicators. The Recovery Rate shown above measures collections percentage from the Total Open A/R Pool for each year.
Total Open A/R Pool for the year can be any age including prior years’ billings. Write-offs do affect this number by reducing Recovery, as those balances are never collected. As you can see, the industry recovers a decreasing amount of its open balances each year.
As expected, this causes the average Days of A/R to increase. Write-offs are also increasing but not in a sufficient manner to account for the 5% decrease in Recovery since 2008. This means firms are carrying more A/R on their books than before.
The write-off percentage above is calculated against the Total Open A/R in that year and includes balances older than the current year.
How does your firm perform compared to your peers? Intelliteach will perform a baseline assessment at no charge. Contact Michael Ferdman at 314.625.9926 for details on sending your data.
A write-off policy affects profits. Does your firm have a policy?
Large firms seem to have been hit the hardest, while the mid-sized firms performed slightly better than the other groups.
A/R Aging Percentage By Bucket
This is a look at the distribution of A/R by age buckets. As you can see, the industry carries a heavily back-weighted inventory. In some practice groups a 6-month retainer or greater payment cycle is acceptable. For most others it should be considered intolerable. Remember that as A/R inventory ages, firms collect less than full value. Having 30-35% of the firms’ A/R aging past 180 days means that the firm will recover far less than 100% of these invoices.
The industry averages just 44.1% collection rate when invoices pass the 180 day old mark. This type of graph is sometimes referred to as a Dumbell Distribution. All the value is on the front and back with little value in between.
Many firms report that this back weighting is somewhat affected by ebilling. Ebilling is approaching 25% of total billings, according to our research. Isolating ebilling from these calculations provides interesting results and will be covered in future articles.
This is a look at how well firms collect over time. There are many ways firms calculate this, but the fact is, as invoices age you collect less of the value. An increase in collection realization of only 0.1% would yield large results in profits and cash-flow.
Remember that all expenses are paid at this point so the increase in collections represents pure profit. More importantly, whatever your firm policy, if collections activities are moved up 30 days, say from 90 days to 60 days, your likelihood of collections success increases dramatically (15%). Notice that large firms collect more over time but mid-sized firms collect a higher percentage of their aged A/R.
Industry-Collection Realization By Size
Industry Bill Speed and Collections Speed
The above chart illustrates how long it takes the average firm to bill, and more importantly, to get paid. We look at how old the WIP was, on average, when it was billed, and the same for A/R age when it was paid. Notice that the smaller firms are the quickest to bill, but the slowest to get paid, highlighting the fact that it is not enough to concentrate on only one area.
These are dollar-weighted, so they highlight the true momentum for the firm, as opposed to individual invoice counts.
Industry Days of Accounts Receivable
Industry Days of Accounts Receivable by Size
The average firm has 73 days of A/R in inventory. This measure has increased by 3 days over the last 12 months. Ebilling seems to be a factor in why the industry is getting paid slower, but the main response to our surveys is that clients are holding onto cash and paying vendors slowly.
Large firms seem to perform better in this area by collecting invoices faster. This could be due to the diversity of services delivered by larger firms (a varied client base), better internal controls, better ebilling policies, or a combination of factors.