How to Run the Business Side of Personal Injury Practice

Seventh in a Series of Quarterly Columns
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Numbers are to the Business of Law
What Facts are to the Practice of Law:
You Can't Win Big Without Either
  
by
William L. Speizman
America's #1 Business Consultant to the Plaintiff's Bar


If you go to trial without knowing the facts in a case, your chances of winning are greatly reduced. Similarly, if you run the business side of your practice without knowing its numbers, your chances of maximizing your income are greatly diminished. Moreover, ignorance of the facts in court or the numbers in your business can lead to crises, firefights and disasters.
In this column, I am going to discuss two examples of the quantitative parameters of your personal injury law business. I’ll demonstrate their computation and illustrate the role they can play in making sound business decisions.

Average Fee per Case

This is one of your most powerful practice management numbers. You can use it to project cash flow and choose which marketing efforts to invest in.
The simplest way to calculate your Average Fee per Case is to divide the fees you garnered in a twelve month period by the number of cases you closed.
The problem with this simple approach is that statistical averages are highly sensitive to extreme values. For example, if each of ten cases generates a fee of $10,000.00, their average fee is $10,000.00.  But if one of the ten generates a fee of $100,000.00, their average fee jumps to $19,000.00, nearly double.
Exceptionally large fees from super cases of the sort that rarely come along are extreme values. You should exclude them from the calculation of your Average Fee per Case. If you don’t, you run the risk of overestimating it. In turn, you could draw erroneous conclusions based on an inflated Average Fee per Case and end up making deleterious business decisions.
Here’s a systematic procedure for identifying and excluding exceptionally large fees from the calculation of your Average Fee per Case:
First, choose a line of demarcation between your Typical or T-Cases and your Exceptional or E-Cases. T- Cases render fees typical of most of the cases you close. E-Cases generate fees that are substantially greater than those produced by your typical cases. The dividing line between T-Cases and E-Cases varies from practice to practice. In one practice it might be $15,000.00; in another, $55,000.00.
Choosing your line of demarcation is an art rather than a science. A rule of thumb you can use to choose it is: the largest fee that is typical for your law firm is one that you’ve garnered a minimum of three times per year in each of the previous three years. Any case that generates a fee in excess of that amount is an E-Case.
Second, once you’ve chosen your line of demarcation, review the cases cashed out in the twelve month period on which you are basing the calculation of your Average Fee per Case. The purpose of this review is to identify then count the number of E-Cases you closed.
Third, subtract the number of E-Cases from the total number of cases you closed. This gives you the number of T-Cases you cashed out.
Fourth, add up the fees garnered from your E-Cases and subtract them from the total fees you garnered during the twelve month period on which you’re basing your calculation. This gives you the fees produced by your T-Cases.
Finally, divide your T-Case fees by the number of T-Cases you closed. The quotient is your Average Fee per Case.

Overhead Rate
This is the ratio of your Operating Expense to your Operating Revenue. For example, if you were to generate $3,000,000.00 in revenue and your expenses on your Profit and Loss Statement were $2,000,000.00, your ratio, or Overhead Rate, would be 66.7 percent.
In general, that would mean that for every three dollars of revenue you receive, two are needed to defray your operating expenses.
You should also exclude your E-Case fees when you are calculating your Overhead Rate. If you don’t, you could end up underestimating it. For example, if the $3,000,000.00 in revenue I just cited included an E-Case fee of $250,000.00, the 66.7 percent Overhead Rate could be an understatement. Excluding that fee, your Overhead Rate would jump to 73 percent. That would mean you could apply only 27 percent of each average fee to pay for, say, a yellow page ad. That’s 18 percent less than with an Overhead Rate of 66.7 percent.
When calculating your Overhead Rate, you should not adjust the total Expenses that appear on your Profit and Loss Statement, except in two instances. First, you should exclude any expenses directly attributable to work on E-Cases. For example, if you hired a paralegal to work exclusively on an E-Case, and he moved to a job at another law firm as soon as the case was settled, you should subtract his salary and benefits from the total Expenses on your Profit and Loss Statement. Second, if you are using your Overhead Rate to decide whether to continue or eliminate a marketing effort such as a yellow page ad, you should exclude your Marketing Expense from the total Expense on your Profit and Loss Statement. That way, you won’t burden the marketing effort you’re considering with helping to defray the cost of your other marketing efforts.

Knowledge of Your Average Fee per Case
And Overhead Rate Can Come In Handy:
An Example

Based on the discussion to this point, see if you can spot the flaws in the procedure an attorney used in deciding to renew a $12,000.00 a month ad on the back of a yellow page directory. (This scenario is based on actual events.)

Before he signed the initial contract for his yellow page ad, the attorney computed his Average Fee per Case by dividing his aggregate fees for the preceding twelve months by the number of cases he had closed. He concluded that his Average Fee per Case was $4,000.00 and his ad would have to produce just three run-of-the-mill cases every thirty days to pay for itself.
The attorney had always been a stickler for sourcing of his cases. Seven months into his initial contract, he examined his tracking data and discovered that his ad wasn’t producing three cases per month, but four. He also noted that all of those cases fit the profile of his law firm’s Typical Cases; none was likely to produce an exceptionally large fee.
Before he met with his sales rep to sign his second contract, the attorney decided to have a friend who is an accountant give his numbers a once-over. He sent an email to his friend and attached his Profit and Loss Statement, the data he had used to compute his Average Fee per Case and his tracking data. He noted in his email that fifteen months earlier he had closed the two “whopper” cases he had been talking about and working on for years. One check was for $175,000.00, the other $203,000.00.
His friend called him two days later. “Not only isn’t your ad making a profit” she told him, “you’re on track to lose $96,000.00. Bail out!”
The attorney was shocked. He couldn’t believe his ears. “How can that be?” he asked himself.

By now, you should be able to give him some hints as to how he had gone wrong.
First, because he hadn’t excluded his E-Case fees from his calculation, his Average Fee per Case was skewed to the high-side. After excluding that $378,000.00, his friend calculated the attorney’s Average Fee per Case at $3,600.00 not $4,000.00. Second, the attorney had neglected to compute his Overhead Rate and dun each of the fees his ad generated for its fair share of his overhead. After excluding the $378,000.00 and the aggregate marketing expense from the attorney’s Expenses on his Profit and Loss statement, the accountant calculated the attorney’s Overhead Rate at 72.2 percent.
Because of his unusually high overhead, the attorney could only apply $1,000.00 of each $3,600.00 average fee to defraying the cost of his ad. The remaining $2,600.00 had to go toward covering his operating expenses.
As it turned out, the four cases the attorney had been signing up each month provided a total of $4,000.00 of the $12,000.00 he needed to pay for his ad. So he was losing $8,000.00 per month and on track to lose $96,000.00 that year.
Had he not asked his friend to look over his numbers, the attorney would have renewed his ad and positioned himself to double down on his loss of nearly $100,000.00.

Five Points To Keep In Mind
1. Prudence dictates that when it comes to computation of the financial parameters of your business, conservative methodologies should prevail. That’s why you should exclude E-Cases from the calculation of your Average Fee per Case and Overhead Rate. Who knows when you’ll cash out another E-Case? By the same logic, you should exclude from the calculation of both parameters any referral fees paid to you by other attorneys. However, if you receive predictable referral fees from other attorneys on a regular basis, you should consider including them in your calculations.
2. One very smart thing the attorney in the scenario did was to have an accountant review his numbers before pulling the trigger. Business people needing legal services are advised to draft their own documents before seeking counsel. This saves money. It forces business owners to think through the projects they’re considering very carefully. It also allows them to bring to bear the intimate knowledge of their enterprises which an attorney is unlikely to possess.
Similarly, working up your own numbers forces you to think about what’s going on in your practice and why. But once you’ve computed them, have your accountant review your calculations before basing business decisions on them. Also, sometimes there is a variety of ways to calculate a particular parameter. For good reasons, your accountant may urge you to use an alternative to the one you have chosen.
3. In choosing the line of demarcation between your T and E-Cases, I recommended using the rule of thumb of at least three cases with fees of a certain amount closed in each of the past three years. After thinking about it, you may conclude you should use an alternative rule such as two cases over three years or three cases over two years. Whatever rule you choose, your goal should be to strike a balance between prudence and excessive rigor.
4. You shouldn’t just set and forget your Average Fee per Case and Overhead Rate. Calculate them on a regular basis, say, every quarter using the twelve months prior to that quarter. This will give you an opportunity to pick up trends and observe sudden changes which may be early warnings that things are going awry or improving markedly. In either case, getting better or worse, those changes should summon you to seek their causes. Responding to that summons you may discover something you need to eliminate or something in which you need to invest more heavily.
5. You may be concerned about using averages and ratios to run your practice. After all, they are only summaries of data not the raw data themselves. Most business owners compute averages, ratios, standard deviations, etc. and base their business decisions on them. For example, prior to beginning my consultancy with the plaintiffs bar, I was marketing director at the third largest independent medical group in the country. We were doing $40 million in annual revenue at that time. Not only was the group run using averages, ratios and standard deviations, it never could have been as successful as it was if it weren’t.

Conclusion

I hope this discussion has heightened your sensitivity to the practical importance of knowing, rather than assuming, surmising or guessing, what’s going on in your practice. I know you’re busy and that monitoring your business takes time. But as the old saying goes, “a stitch in time saves nine.”


Copyright 2009 William L. Speizman
All Rights Reserved

wlspeizman@gmail.com