The Role Of “Effective Rate” To Law Firm Profitability

There are 6 main profit drivers for all law firms:  Rate, realization, leverage, margin, operating expenses and cash flow.  Rate can be tracked in several ways.

• Standard rates are rates you would charge a client, all things being equal.  These are typically your highest rates.
• Worked rates are your actual rates you charge a client.  Worked rates are affected by client negotiation or perceived need to reduce rates to stay competitive.
• Billed rates are rates after you invoice a client.  Billed rates take into consideration both mark-downs and discounts.
• Collected rates are the final hourly fee after the invoice has been reduced to a zero balance.  Collected rates take into consideration write offs and other post-bill adjustments.

Rate can be measured from standard to billed or worked to billed to judge how well you are converting your work to invoiced fees.  These rates are measured on an accrual-basis.

Rates can also be measured from billed to collected.  These rates are measured on a cash-basis.

However, to get a full view of what happens to your standard rate as work moves through the billing cycle, firms need to measure the effective rate.  The effective rate can be measured either from standard to collected or worked to collected.

Measuring effective rate means creating targets, forecasting results, and holding your fee earners accountable for results.

The below chart shows how you can measure effective rate.  Click on the graph to download.

Tracking Billing Cycle Metrics

The law firm business model is based on the measurement of 5 key profit drivers:  Rate, Realization, Utilization, Leverage, and Margin.  I would add another metric:  Cash flow.  You can really see a return on your investment in time and effort if you have a lot of time in WIP (work in process) and AR (accounts receivable).

The critical metrics that affect cash flow are the average days to bill, average days to collect (and by extension the sum of both to create the total billing cycle) and the average days in AR. Using a rolling 12 month period will give you an annual baseline, but you can also track it monthly. 

In the graph below, The variables are the total fees unbilled, total fees billed, and total fees collected over a 12 month period.  Knowing these numbers, you can calculate the total receivables outstanding during this time span, the average monthly and daily fees unbilled, billed and paid and your average days to bill, collect and days outstanding.

These metrics are critical for measuring your efficiency both at billing your work and collecting your fees.  If these numbers are high, then a review of your processes is due. Click on the graphic above to download and test with your own numbers.