There is a bewildering plethora of business management metrics out there. Often some of these dominate far too much management time whilst others are left ignored. So, which are the most important law firm key performance indicators? Let’s take a look at some of the more obvious ones and a few that are often overlooked.
No prizes for guessing that this one would come top of the list! Cashflow is the key marker of business performance. It allows you to determine if your sales margins are appropriate and is the main indicator looked at by the banks.
To create your cashflow forecast, simply add the total cash your practice has in savings to the projected cash value for the next four weeks, then subtract the projected cash out for the next four weeks. Performing a regular cashflow forecast is a must for all businesses. It will allow you to identify problems early and make appropriate adjustments.
As well as helping you prepare for future surpluses or shortages, a cash flow forecast is crucial for tax planning and loan applications.
Gross Profit Margin as a percentage of sales.
This is a key indicator of the health of your practice. The formula to calculate it is:
Find your gross profit margin (GPM) by dividing your gross profit amount by your sales. Then multiply that by 100 to create a GPM percentage. Finally, divide that value by your sales figure to reveal how much of your GPM makes up your overall sales.
This particular KPI allows you to keep track of how much money you are retaining against the amount you pay out. A decrease in GPM as a percentage of sales is a clear indication that you are spending too much on overheads. This allows you to make the adjustments to overhead costs or to increase fee rates.
Accounts Payable Turnover.
As I have said many times before, lack of profit does not mean that your business will fold. It’s the failure to pay suppliers of all varieties that causes the real problems. Your accounts payable turnover is a measure of the rate at which your practice pays for goods and services.
To establish this figure, calculate the total cost of purchases from suppliers and divide that by average accounts payable. When you have worked out how much you spend on suppliers, you can take appropriate action. If you take steps to reduce spending on suppliers, you will effectively boost your long-term profits.
I don’t intend to dwell on this point for long as there is a more in-depth article on lock-up available here: Lock-up: are you cracking the WIP?. Lock-up is the sum of unbilled work in progress and debtors (excluding VAT). It is an excellent measure to view in tandem with your cashflow forecast. A high level of lock-up days will invariably have a detrimental impact on your cashflow. It pays to keep this indicator as low as possible – you are not in practice to bankroll your clients.
Income Growth rate.
This KPI is an obvious one to track, but is often overlooked in the legal sector. Put simply, it is the rate at which your practice’s income is increasing (or, decreasing!). You measure it by taking your total income for the current year and dividing it by total income for the last year.
If you perform this check on a regular basis, you can determine whether business is growing, shrinking or remaining stable. Its key use is to determine whether you need to cut costs on the one hand or gear up to meet new demand.
For a high-street practice, market share can be an esoteric measure that is difficult to calculate. However, it is a critical indicator that illustrates how your business is performing in the light of your competitors.
To use the measure effectively, firstly define your market. This may be the conveyancing and family law market for a given geographical area or some other measure appropriate to your practice specialisms. Unless you have access to your competitors’ financials, the remainder of the equation will be a relatively educated piece of guesswork. If you know who your competitors are, you can broadly measure their share by counting the number of fee earners they employ and using this to create a turnover figure for them based upon your own turnover per fee earner ratio.
Once you have a total turnover figure for the size of your given market, divide it by your own turnover and multiply by 100 to reveal your market share. With this figure available, you can make adjustments to your business strategy, pricing and service offerings to improve your competitiveness.
Above and beyond Financials: Marketing KPIs?
Naturally, there is a whole host of alternative KPIs with varying degrees of relevance dependent upon your practice type. The ones above are largely financial / accountancy based – in other words: counting what is already there. Probably of greater importance to any business are those KPIs that focus upon the business functions which put something there to count in the first place.
Measuring your marketing and business development activity by the use of Law Firm Key Performance Indicators is equally as important. It really is simple; if you don’t market yourself, you won’t generate business. Effectively you won’t have a business. In the next article I intend to take a closer look at marketing and business development KPIs and lift the lid on the “Black Art”.
Mike O’Donnell, March 2017.
Mike O’Donnell is an experienced marketing professional who has spent much of his career working in and advising the legal profession.