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How to Manage a Law Firm for Profit

How to Manage a Law Firm for Profit

You got into law for a noble purpose: you want to help people. And that’s a beautiful thing, but you can’t help people if you can’t pay your bills. Yet, most lawyers refuse to acknowledge a simple fact: you are running a business and profit is your #1 goal.

Knowing your numbers and getting into a rhythm of reporting them is the first step to running profitable law firm.  Begin with 4 numbers:

#1:  Gross Revenue

#2:  Operating Expenses

#3:  Salary Cap (a/k/a cost of labor)

#4:  Pretax Profit

#1:  Gross Revenue: The money generated by your law firm, including legal fees, referral income, books sales, etc.  Gross revenue is every penny that is deposited into your operating account.

#2:  Operating Expenses:  Know exactly what it takes to run your law firm. The operating expenses will fall into 1 of 6 categories:

  1. Salaries
  2. Rent
  3. Marketing
  4. Payroll Taxes and Benefits
  5. Insurance
  6. Other Operating Expenses

Other operating expenses include office supplies, IT support, costs of software for case management, customer relationship management (CRM) and lead intake, telephone and internet, payments for debt (e.g., interest on line of credit).

#3:  Salary Cap (a/k/a cost of labor)

You should know your law firm’s salary cap or the cost of labor, including your market-based wage (salary and bonus).  Set your market-based wage by asking this question:

“Think of it like this: If you got run over by a bus today and your heirs decided they would keep the business going in your absence, what would they have to pay someone to do your job?”

Greg Crabtree, “Simple Numbers, Straight Talk, Big Profits!

If it would cost $240k to replace you, then that is your market-based wage and that is what you should be paying yourself (salary and bonus). If you underestimate your market-based wage, you will over-state your firm’s net income.

#4:  Pretax Profit

The only thing that matters is profit, namely, how much money do you take home.  Revenue is irrelevant.  Many lawyers strive to get bigger and increase revenue, but when they do, overhead expenses grow and it becomes a continual battle to pay the bills. For my two cents, your philosophy should be, Keep it small and keep it all.

Your pretax profit is the profit you make after you take your revenue minus costs, before you pay taxes.   The pretax profit for a small firm will almost always exceed that of a large firm. A larger firm (20-25 employees) might be thrilled with a pretax profit of 15%, while a small firm (5 employees) can consistently have a pretax profit of 50%.  When overhead expenses are low, profit is usually high.

“The goal, first and foremost, is to run a profitable company.”

Greg Crabtree, “Simple Numbers. Straight Talk. Big Profits!

The amount of $ that you pay the IRS is the only key performance indicator that matters.  When you pay more taxes, your law firm is healthy. You should celebrate when you pay a big tax bill. Seriously.  Paying a big tax bill means you’re running a profitable law firm.

3 Numbers for Forecasting Your Income

To forecast your firm’s net income over the next 12 months, you’ll need 3 numbers:

#1:  Trial Dates: # of confirmed trial dates over the next 12 months,

#2:  Settlement Values: Settlement value for each case with a confirmed trial date, and

#3:  Legal Fees: Legal fee for each case (after referral fees) with a confirmed trial date.

Let’s say you have 4 confirmed trial dates over the next 12 months.  Conservatively estimate the most realistic settlement value and your firm’s legal fee (after paying referral fees) for each case that has a confirmed trial date. Once you tally the legal fees for the 4 cases, you know what your law firm’s income will be over the next 12 months.

No trial dates over the next 12 months?  That’s a problem, my friend. Without a trial date, you cannot forecast income for your cases.  Make it a priority to get confirmed trial dates for your biggest 2-3 cases over the next 90 days.

Keep a Scoreboard of Your Numbers

Buy a whiteboard and keep a scoreboard of your numbers. When it comes to your key financial numbers, less is more.  Put the numbers on an actual Scoreboard—focus on the Scoreboard and make that the focus of your financial meetings. The Scoreboard will provide immediate, visual feedback.

Here’s what your Scoreboard might look like:

#1:  Revenue:  $1,100,000

#2:  Operating Expenses:  $550k

#3:  Salary Cap (a/k/a cost of labor):  $325k

#4:  Pretax Profit: 50%

#5:  Income Forecast (for next 12 months):  $750k

Compare your profit and loss on a year to year comparison and month-by-month over the last 12 months (e.g., rolling 12 month profit and loss).  This will show whether you’re doing better from year to year and whether your profit is trending up or down over the last 12 months.

Know Your Budget and Target Allocation Percentages

How often do you review your profit and loss statement and balance sheet? Be honest.  Meet with your Financial Team (bookkeeper and accountant) once every 6-8 weeks to review your profit and loss and balance statement.  

Go through the variable expenses, e.g., office supplies, and ask your financial team, “Do we really need this?” Cancel whatever is not absolutely indispensable to run your law firm, such as recurring monthly fees for things you don’t use.  Whenever possible, negotiate with your vendors to lower expenses.

Determine the percentage of every major expense relative to your gross revenue, e.g., if your revenue is $1M and salaries are $500k, salaries are 50% of your gross revenue.  Your bookkeeper should provide the Current Allocation Percentages for every category of your major expenses and pretax profit—this is a snapshot of where you stand right now.  Your marketing budget might include sub-categories of your biggest expenses, e.g., TV advertising, seminars, etc.

Current Allocation Percentages (as a % of Revenue)

Salaries: 50%

Marketing: 7%

Rent and Supplies: 23%

Net Income Before Taxes (Pretax Profit): 20%

Then, you should create Target Allocation Percentages (“TAP”) for those categories—this is where you want to be in the future.

Target Allocation Percentages (as a % of revenue)

Salaries: 42% (down 8%)

Marketing: 15% (up 8%)

Rent and Supplies: 15% (down 8%)

Net Income Before Taxes (Pretax Profit): 28% (up 8%)

Your Target Allocation Percentages have reduced allocation percentages for your operating expenses, e.g., salaries, rent and supplies, and higher allocation percentages for the things that matter most, namely, marketing and pretax profit.  Your goal as a business owner? Low overhead, high profit.    

Thank you to Alex Nguyen, Esq., a numbers guru, former actuary and exceptional entrepreneur/injury lawyer in Atlanta, for sharing this tip!

Take Your Profit First

Create separate accounts for profit and taxes.  The accounts are created a different bank (your “no temptation” bank) from the bank where you have your operating and escrow accounts.  You will call these accounts: PROFIT HOLD and TAX HOLD.

Every time you make a deposit, move 1 percent into the Profit Hold and Tax Hold accounts.  By moving profit and tax into a separate bank account, you keep those funds out of sight and beyond your temptation to access them.

“Profitability isn’t an event. It’s a habit.”

Mike Michalowicz, “Profit First

As you get used to setting aside money for profit and taxes, increase the amount that you deposit in those accounts and set targets (a/k/a target allocation percentages) for your profit and tax hold accounts.  The goal is to pay yourself first from every dollar you earn and set aside money for taxes so you’re not scrambling to pay taxes on April 15th.

3 Simple Ways to Instantly Lower Your Taxes

Prepay Expenses: You can prepay expenses (e.g., rent, malpractice insurance, phone and internet fees, etc.) for up to 6 months at the end of the calendar year and deduct the expense in the year the expense was paid. This will lower your overhead expenses in the following year and increase your tax deductions (and lower your taxable income) in the year that you prepay the expenses. This is a no-brainer!

Do not increase your business expenses simply to increase your tax deductions.  Spending money to save money makes no sense.

Max-Out Your Retirement Plans: Make the maximum contribution to your 401(k) and Profit Sharing accounts or a defined pension benefit plan.  For every dollar that you invest in your retirement account, you’ll save about 40-50% on your taxes.

When you make a contribution to the retirement plans of your staff, you reduce your taxable income and get props for investing in their future. Your retirement contribution to your staff’s 401(k) and profit sharing accounts can be their end-of-the year bonus.

Defer Your Legal Fees in Personal Injury Cases: With a structured settlement annuity in personal injury cases, you can defer taxes on your income.  For every dollar you put in a structured settlement annuity, you’ll save about 40-50% on your tax bill.

You can pay the future operating expenses of your law firm (or fund your retirement plan) by structuring the legal fees in personal injury settlements. One Caveat: You’ll need the consent of counsel for the settling defendant to invest your legal fee in a structured settlement annuity.

Negotiate a Long-Term Lease

Don’t just sign a 3 year lease—think long term. Negotiate a lease that gives you the multiple options (e.g., 8 consecutive 3-year options to renew) to renew at the expiration of each term.  

When you add options to renew to the lease, you have the right to remain in your office until the expiration of the last option to renew (e.g., long enough to stay in the office for your entire career). Just in case you have a change of plans, add a provision that gives you the right to terminate the lease at a fixed price (e.g., you can terminate the lease at any time for 3 month’s rent).

Eliminate Debt and Build Your Capital Reserves

Eliminate your personal and business debt and run your law firm from your capital reserves.  This will take time and won’t happen overnight, but just say “no” to debt. Build 6 months of capital reserves, so you have a cushion for the bad months and occasional defense verdict.  If your operating expenses are $50k/month, set a goal of having $300k in capital reserves.

“Businesses that have cash and no debt attract magical things.”

Greg Crabtree, “Simple Numbers, Straight Talk, Big Profits!

If you pay yourself a market-based wage, you can live off that and won’t have to take profit distributions (a/k/a bonus compensation) from your law firm. You will be more frugal when you’re paying expenses with your own money rather than a line of credit.

Create a Succession Plan for Your Law Firm

Create a succession plan that leaves nothing to chance.  If you die today, your law firm will be worth $ and your successor will be Shannon Jones, Esq.  Agree upon a method for determining the value of your law firm. The economic value might be based on the last three years of pretax profit plus equity (assets minus liabilities) and the value of your case inventory.

If you do not have a succession plan, your law firm won’t be worth a dime when you stop practicing law. Build a law firm based upon profit and no debt and other lawyers will be dying to buy you out.


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