Key performance indicators (KPIs) for law firms: measuring the financial health of your firm

Monitoring your law firm’s profitability

For small practices, keeping track of financial performance metrics can help you understand how your law firm compares to others of a similar size and support you with achieving growth. 

Here are some KPIs to be aware of:

Fees per fee earner (fee income/number of fee earners)

 A useful measure of growth and, if compared year-on-year, it will help you plan ahead.

Total salary costs as a % of fee income (total people costs/ fee income)

 People costs are the primary cost for law firms (include notional salaries for partners if you are an LLP).

Profit per employee (operating profit/number of employees).

A measure of the firm’s profitability. This formula will need to be adjusted slightly for LLP structures to take account of partner notional salaries.

Overhead rate (indirect costs/fee earner costs x 100%)

A measure of the cost of the services you are providing. Indirect costs include rent, rates and other administrative expenses. The lower the rate, the more profitable you are and it will help you decide how much you should be charging.

Funding your law firm

Law firms are most likely funded by a combination of equity (being partner capital) and debt (external bank loans). 

The following KPIs can be used to help you to decide the best way to fund your firm and benchmark it against your competition:

• Capital per equity partner (total capital, current and tax reserve balance/ number of partners)
• Bank borrowings per equity partner (total bank loans/ number of partners)
• Debt to equity ratio (total debt/ total equity)

Managing your law firm’s cash flow

A top priority for staying in business is to manage cash flow. Most costs are paid monthly or quarterly (like staff costs and premises costs) but income does not always follow the same pattern. Therefore, the easiest way to run out of cash is to not bill clients promptly and to allow debtors to remain unpaid for too long.

There are a number of KPIs that can provide clarity on where you may need to refocus efforts to improve cash flow:

WIP days = (WIP / Last 12 months of revenue) * 365

WIP (work in progress) days are an indication of how quickly you’re able to generate fees from the work done. The lower the WIP days, the quicker the fees are being generated.

Debtor days = (Trade debtors / Last 12 months of revenue) * 365

Debtor days are an indication of how long it takes clients to pay fees. The lower the debtor days, the faster the fees are being paid. This can help you see which clients are slow, or reluctant to settle fees.

Lock up = WIP days + Debtor days

Lock up is the combination of WIP days and debtor days; it indicates how long it takes from starting work for a client to receiving cash for that work. If lock up is high, there is less cash available in the business to meet debts as they fall due, which puts the business at risk.

Here are some of our top tips for reducing your lock up: 

• Review your processes to identify ways of improving billing and debt collection 
• Review old WIP balances – should these balances be invoiced or is a WIP provision required?
• Review old debtor balances – is there an issue you’re not yet aware of?
• Fee earners can sometimes have better success at collecting fees than your finance team because they have the relationship with the client.

Visibility –  sharing your KPIs and engaging your team

When management are using KPIs to monitor business performance, it makes sense to share these KPIs with the wider team so that everyone is working towards a common goal. This can also help your team to feel engaged and connected to each other.

To discuss with us how tracking KPIs can help your law firm, or for assistance with benchmark reporting against other practices, get in touch via the form below.