Why Are so Many Firms Preoccupied with Revenues Instead of Profits? by Gerry Riskin
P
rofits are a better way to measure a law firm’s financial health. This article explores why so many firms are preoccupied with revenues instead of profit and what you can do about it ... If you double your revenues and your margins remain constant, you will double your gross profit. If the number of partners doubles in the same period, you are standing still (well, less the cost of champagne). Why are so many firms preoccupied with revenues instead of profit? Here are the most common reasons firm leaders focus on the wrong numbers: • Various publications rank firms by revenues. Firm leaders are therefore motivated to try to achieve as high a ranking as they can, for both wholesome and unwholesome reasons—wholesome including positioning to obtain marketing advantages, and unwholesome being basically ego. • The partners themselves understand the simplistic measure percentage increase, and it is appealing if you don’t know any better. • Percentage increase included inflation, without highlighting it, so even if there are margin squeezes, revenue enhancement still sounds good. • Revenue is simpler to calculate than profit, at least firm-wide.
THE VISIBILITY TEST When it comes to measuring the performance of individuals, many firms still focus on recorded billable hours. Recorded hours are perceived to have value, so if we know the billable hours of two lawyers, A and B, and B’s are 120 percent of A’s, we can safely assume that B is producing more for the firm than A. Or can we? Some slightly more sophisticated firms measure billings, and even more sophisticated ones measure cash receipts. These measurements fail to disclose the true profitability of the practice, which is ascertainable only by going beyond hours or billings or receipts to include costs allocated to the revenue source. For example, knowing that a lawyer recorded million worth
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Attorney Journals San Diego | Volume 221, 2022
of time is a beginning. Knowing that 0,000 was billed is better, and knowing that 0,000 was received is better yet. But we cannot really assess the value of the practice until we know that the costs associated with that revenue generation were 0,000— producing a net contribution of 0,000.
ALLOCATING COSTS (THE DARK SIDE) Why are so many firms reluctant to allocate costs? Here are some of the reasons: • It is not simple to allocate costs. What do you count and what don’t you count? It may be easy to allocate staff if there is a 100 percent allocation to a group or team, but in the real world it usually gets a lot messier than that. And then there are issues like this: Is the new office in Timbuktu, which specializes in Practice Area X, a cost of that practice area, or is it the beginning of a presence that benefits and adds international credibility to the entire firm and therefore a cost of all practice areas? Having discretion as to allocation creates dilemmas. And we hate dilemmas. • The computer systems may not allow the flexibility to do the combinations and permutations of calculations, or the people who operate those systems may be ill-equipped or just plain reluctant to handle the changes. • Change means some uncertainty, and therefore discomfort. It won’t be done the way we have always done it so successfully. It’s not broken, is it? • Politics. Individuals with significant personal power are not about to allow any new measurement process that they have not already analyzed to the nth power to determine exactly how it might affect them personally. Partners are as sensitive about cost allocation as they are about compensation. • The ramifications of doing the analysis may be dangerous. If practitioners in Practice Group A were to learn how much more profitable they really are compared with Practice Group B, they may begin putting tremendous pressure on decision-makers as to compensation and
