Revenue v. Profits: Don’t Forget the Bottom Line

I recently worked with a successful small law firm owner with a niche practice. His book of business supported him and one associate. So far so good. But, the firm also employed another associate whose focus was in a completely different practice area. That area was completely unrelated to and lacking synergies with the firm’s niche.

I asked the owner about this additional practice area. Here’s how our conversation went.

Me: “Why bother with the other practice area at all?”
Owner: “Well, it provides added revenue.”
Me: “But, are you making money?”
Owner: “I doubt it.”

“I doubt it,” indeed.” A simple look at the P & L indicated that the second associate’s salary approximated the revenue from this lawyer. Throw in the overhead apportioned to the associate, and the practice area that the owner “doubted” was making money was, in fact, losing money.

The Holy Grail of Finance Metrics: Revenue or Profitability?

This lawyer fell into the trap that all-sized firms frequently do. They mistakenly believe the holy grail finance metric to be revenue.

But if you ask anyone working in corporate America what the key finance metric is, you will hear one thing only: profitability. After all, what’s the point of revenue unless you actually make money for your efforts?

Tracking Revenue v. Tracking Profitability

How did the legal profession get there? Here’s my educated guess.

Revenue is easy to measure. But, measuring profitability can get a bit too complicated for most lawyers. For instance, properly allocating expenses is an art and a science that few lawyers want to tackle. Lawyers love to keep score, however, so they turned to revenue as the easiest means to do that. This leaves little to debate when adding up the numbers from invoices paid. The debates increase greatly when it comes to measuring profitability, though. How do you apportion overhead expenses, such as office rent or the salary of a secretary?

It’s Okay to Lose Money if You Make it Up Elsewhere

The only reason to keep an unprofitable practice area in existence is when doing such work more or less acts as a loss leader for far more profitable work at the firm. For example:

  • The unprofitable work sustains the relationship from a firm client who brings in lots of other very profitable work.
  • The work is a significant source of referrals.

Remember to measure whether the added profits for services derived from the unprofitable practice exceeds the losses sustained by the unprofitable practice.

Breaking Even Is Never Acceptable

And for those of you who think that it is somehow OK to do work that simply breaks even, let’s revisit the client I discussed above. We will generously assume the other practice doesn’t make or lose money. Even so, it is still a terrible idea to continue on.

Consider the amount of the owner’s time and support staff’s time managing that practice. With that practice area eliminated, the owner could regain time for either billing or working on business development for the profitable niche practice area. Either strategy will increase the firm’s bottom line, thereby increasing its profitability.

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