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Five ways to improve your law firm's balance sheet

LAW FIRM PARTNERS focus a lot on their profit-and-loss statements but tend to glance over the asset section of their balance sheets. This is a missed opportunity. There are three main reasons assets are largely ignored.

Law firms should identify all the assets used to create and sustain value .

Firstly, in "zero-in zero-out" partnerships with 100 per cent dividend payout ratios tracking long-term asset value is relatively less important.

Secondly, with some firms the accountants lump all intangibles into a vague and unhelpful construct called goodwill.

Thirdly, balance sheets tend to list boring things like plant and equipment.

From a strategic management perspective, there is a significant benefit in framing goals around making the firm more valuable. This means identifying all the assets – tangible and intangible – that the firm uses to create and sustain value.

A more detailed balance sheet can also be useful when it comes to partner
performance management. Growth in asset value should be the heart of what’s expected of partners, especially in regard to their non-financial contribution.

Tangible assets are easy to quantify. The intangibles less so, but there are still five worth measuring, protecting and leveraging.

Relationship Capital

Relationship or social capital refers to the strength and stickiness of existing client relationships and, where relevant, referrer and community connections.

While there are no simple measures of relationship capital, good proxies include total client lifetime value, client commitment indices, net promoter scores, client loyalty rates, average service mix per client, share of wallet of platinum and gold clients, social network strength and percentage of sole-sourced work.

Human Capital

Human capital refers to the quality, performance and commitment of all partners and staff. Management reports often include data on salaries, recruitment, training and turnover, but these don’t get to the heart of tracking human capital growth or depletion. Additional measures might include:

  • Toe-to-toe analysis comparing the quality of key practitioners in the firm versus direct competitors;

  • Loyalty and career intention indicators;

  • Succession and talent development pipelines by practice area;

  • Diversity and inclusion metrics;

  • Glassdoor, Seek and social media ratings;

  • Employee net promoter scores;

  • Leadership capacity and capability;

  • Culture maps, highlighting hot spots or blind spots; and

  • Real-time measures around staff morale, firm climate, employee experience and discretionary effort.

Brand Capital

This refers to the strength of the firm’s brand and reputation in key target markets. Traditional measures include brand awareness, consideration, preference, use, board room impact, recommendation and social media following. An ability to attract star recruits is also an indicator of brand capital.

One benefit of a strong brand is the ability to command a price premium. By way of example, in 2019, Apple’s brand premium enabled it to capture 66 per cent of smartphone industry profits, 32 per cent of overall market revenue while only selling 13 per cent of total handset units.

Factors include the percentage of bids won when the firm was priced higher than competitors, depth of discounting and percentage of matters with supernormal margins.

Data Capital

Most firms are sitting on mounds of valuable data with most of it stored on disconnected databases collecting digital dust. The main data islands include:

  • Client data such as matters delivered, interactions, service feedback, event participation, agreed pricing and billing;

  • Staff data such demographics, salaries, tenure, engagement, training, feedback and performance records;

  • Operational data such as time records, productivity and utilisation; and

  • Financial data such revenue, margins and expenses.

The analysis could point to using a specific team with a particular process to do a specific type of matter for a certain client category using a defined pricing model.

Each of these choices might mean a 2 per cent improvement, but accumulatively you’re looking at gains of more than 10 per cent without working any harder.

Intellectual Capital

The last category is firm know-how. This might include the proprietary legal products, algorithms, websites, domain names, precedents, templates, applications, patents and trademarks.

Growth can be assessed by the firm’s investment in research and development and its innovation portfolio. Revenue from new products can be a good indicator.

Take a quick glance over your firm’s strategy papers and board reports over the past 12 months. Is there a way to elevate your firm’s strategy thinking by delving into the intangibles that will sustain your long-term success? I bet there is.

Credit to Author: Joel Barolsky is managing director of Barolsky Advisors and a senior fellow of The University of Melbourne.

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