Focus on “Collection Rates” to Improve Law Firm Profits
More and more law firms are realizing how important it is for law firm profitability to concentrate on collection rates as opposed to just billed hours.
The legal sector has witnessed a decline in collection rates in recent years. Law firms are under pressure to sustain and grow their profitability due to economic concerns and heightened competition.
For example, a recent Thomson Reuters survey revealed that collection rates have been declining to as low as 87% for the largest law firms, and 90% for mid-sized firms.
Similarly, a majority of firms “struggle with the collection process," according to a recent Legal Trends report from Clio.
In other words, even when clients pay their bills, they frequently fail to pay the entire amount owed. Rather, they are only paying a portion of their bills, leaving law firms to write off the remaining amount.
This makes it perilous for law firms to focus on the number of hours billed, and on hourly rate increases. Instead, it is imperative that the focus be shifted from potential earnings to collection rates, as this will connect the firm's financial health with actual revenue inflow.
Importantly, current developments in artificial intelligence (AI) and associated billing applications can be quite useful in addressing this issue.
What Are “Collection Rates"?
Law firms usually monitor a number of billing-related rates, including standard, worked, billed, and collected rates.
Standard rates resemble list prices — they are the prices for legal services that are advertised. Worked rates are typically less than the standard rates — these are the fees that clients agree to pay when hiring a law firm. Billed rates represent the actual amount clients are charged, after the law firm makes any modifications known as write-downs.
The hourly rates that clients ultimately pay after reviewing the invoice and making additional adjustments—often referred to as “cuts," “write-offs," or “write-downs"—are known as collected rates.
“Collection rates" are the percentage of services invoiced that clients actually pay, after deducting completely unpaid bills from the total. The entire amount of funds received divided by the total billable services in the same fully or partially paid invoices during a given period of time yields the collection rate.
A high collection rate indicates that the firm is effective in being paid more of the fees it invoices, which is crucial to the firm's bottom line. On the other hand, a poor collection rate may indicate problems with billing procedures, market positioning, or client pressure.
For law firms, the collection rate is a crucial performance metric that shows how well their billing and collection procedures are working.
The metric is essential as it has a direct bearing on profits and revenue.
Collection rates are a clear indicator of the company's capacity to turn work into money, which is a foundation of every for-profit enterprise.
Because collection rates involve getting paid for all the services earned and expenses advanced, rather than for only part of those services and expenses, they are frequently a better way for law firms to improve profits rather than raising hourly rates.
For example, raising the hourly billing rate is useless if the fees are not fully paid.
In other words, if a law firm increases its rates, but then the clients pay less of the hours billed, the increase in hourly rates has not resulted in improved revenues.
Similarly, if the client does not pay for all of the hours billed, it is pointless to work a lot and accumulate billed hours for the client.
In other words, doing a lot of work on a matter can end up backfiring, if the client refuses to pay for the extra work.
Focus on “Collection Rates" When Getting Paid
Too many law firms focus their collection tactics only on receiving payment, with efforts to minimize payment delays and obtain at least partial payment, rather than also addressing the maximization of collection rates.
Of course, it's critical that law firms concentrate on collecting payment. Firms can achieve this by providing clients with various payment choices, keeping lines of communication open on invoicing and payments, and establishing clear payment arrangements at the beginning of client engagements.
Additionally, as is all too frequently the case with law firms, collection efforts should be handled early and frequently throughout the year rather than just in the fourth quarter to ensure that they receive at least some payment.
Additionally, law firms should handle collections with a perspective that strikes a balance between client relationships and financial recovery.
However, maximizing collection rates necessitates a more client-centered strategy.
To put it plainly, maximizing collection rates entails making sure clients do not receive excessive bills.
Nobody want to pay an excessive bill.
In fact, reasonable billing is required of attorneys by ethical rules. More precisely, “[a] lawyer shall not make an agreement for, charge, or collect an unreasonable fee or an unreasonable amount for expenses," according to Rule 1.5 of the ABA Model Rules of Professional Conduct.
This essentially means that attorneys have to use “billing judgment" and “make a good-faith effort" to omit costs and charges “that are excessive, redundant, or otherwise unnecessary." Hensley v. Eckerhart, 461 U.S. 424 (1983).
In practice, to avoid charging unethical fees, lawyers should review their billing entries and “pre-bills" before submitting them for payment. In order to satisfy the needs and expectations of its clients, law firms should also make any necessary alterations or adjustments.
This calls for careful invoicing to prevent glaring mistakes like charging fees or expenses for the incorrect matter, charging twice for the same services or expenses, or inadvertently charging more for a time or expenditure item than was actually incurred.
It also entails billing with an eye toward the expectations of the client. This helps guarantee that the client won't object to paying a bill, which would lower the profitability of the services rendered.
Perhaps just as crucial, client-focused charging contributes to the long-term viability and success of the client relationship in addition to promoting client satisfaction, repeat business, and even recommendations from satisfied clients.
In order to do this efficiently, law firms should consider utilizing AI-powered billing solutions that, by learning from the law firm's own historical billing data, can lower the possibility of billing disputes and reductions and raise the likelihood of payment.
With the use of these AI-powered apps, law firms can even adjust their work to reflect what the client would actually pay for. In addition to minimizing pointless work, this also results in notable increases in law firm profitability and collection rates.
Law Firm Profitability Factor: Focus on Revenues, Not Billed Hours
Sustaining a high rate of collection is a sign of sound billing processes. These are critical to a law firm's overall financial stability and survival in the highly competitive legal market.
Stressing collection rates promotes efficiency and accountability. It encourages attorneys to ensure that the client pays the maximum amount of the billed values, in addition to keeping track of their billable hours.
Sound billing procedures can help law firms build stronger client relationships because proactive businesses that pay attention to collection rates are more likely to communicate with their clients in general, which reduces conflict and helps law firms understand what the client expects from their bills.
Conclusion
One important indicator of a law firm's profitability and financial health is its collection rate.
On the whole, focusing on collection rates instead of on billed hours will result in a more profitable and sustainable practice, as it guarantees that the firm's efforts are not only acknowledged but also compensated.
Legal billing software with AI capabilities can make this procedure more efficient and simple to achieve.