Monday, April 30, 2012

Final Meeting with the Auditors

Parsley Sage Rosemary & Ginsburg llp
“always a reasonable result for a reasonable fee, always”

Management Committee
Accounting Department
Mike Marget
April 30, 2012
The Auditors are Coming!  -- Final Meeting with the Auditors

We have scheduled the Final Meeting with the Auditors and Management Committee to occur in conjunction with the May Management Committee Meeting on May 21st. 

As you know, Beane & Beane, CPAs completed their examination of the 2011 financial statement at the end of March.  Copies of the final financial statements, together with the auditor’s report, have been circulated to Big Bucks Bank, Monopoly Holdings (our landlord) and to Easy Credit Leasing – all in accordance with our agreements with those outside parties.  Copies also have been posted on the “partners only” section of the firm’s Intranet for partners who enjoy reading financial footnotes.

On May 21st, the first agenda item will be the meeting with one of the partners from Beane & Beane.  He will discuss the following:

·        How his firm went about examining our financial statements for 2011, the type of tests and analysis performed and comment upon the cooperation received from me and other members of the Accounting Department.    

·        The report issued by his firm and its scope and limitations.

·        Suggestions for improvement in our operations in their Auditor’s Recommendations Letter.

As in prior years, I will ask senior members of the Accounting Department, especially those who worked to prepare the Audit Binder and responded to requests from the auditors during the course of the examination, to be present from the Beane & Beane presentation. 

When the presentation is concluded, the Accounting Department personnel and I will leave the conference room so the Management Committee can meet in executive session with the Beane & Beane partner without any of us present.  This is an opportunity for the Management Committee to ask candid and probing questions concerning our financial stewardship of the firm’s books and records. 

Even after 25 years of doing this job, this executive session is always the most anxious 30 minutes of my year.  Even though nearly five months will have passed since the end of 2011, it is not until the auditor emerges from the executive session with the Management Committee that we can finally declare fiscal year 2011 officially closed.  A week later, we start preparing, slowly at first, to repeat the whole process for 2012.

[I keep hoping one day, you will call me back to the conference room, after Beane & Beane departs, and greet me with a standing ovation for a job well done.  It could happen.]

Friday, April 20, 2012

Auditors' Recommendations Letter

Parsley Sage Rosemary & Ginsburg llp
“always a reasonable result for a reasonable fee, always”

Accounting Department
Mike Marget
April 20, 2012
The Auditors are Coming! -- Auditors’ Recommendations Letter

Let’s be honest with ourselves.  No accounting operation is perfect.  This is why we are committed to continuous improvement and adopting “best practices” which make sense.

In the course of their work on the firm’s financial statements for last year, the auditors made notes of things they wish to discuss with us aimed at improving our operations.  These are compiled in a document referred to as the Recommendations Letter.  You will note the Letter’s format is organized as follows:

·        Brief description of the recommendation and the underlying factors, events or transactions underlying the recommendation; and

·        Brief description of the Accounting Department’s position as to the recommendation – i.e., whether we support the recommendation or oppose it and the basis for such opposition.

Attached is the list of recommendations the auditors propose including in their Recommendations Letter which will be discussed with the Management Committee following the conclusion of the audit.  I would like your views on each recommendation.

In past years, I have sometimes talked the auditors out of including certain items in their Letter.  Occasionally, I have opposed a recommendation which they have made.  Several times I have suggested they include items which they did not identify on their own.  For instance, this year, I plan will be asking them to include a recommendation that the firm move from mailing paper invoices to exclusive use of email for client invoicing; their support of this initiative will make it easier to implement when the proposal goes to all partners.

Wednesday, April 11, 2012

Positioning Your Firm for Max Efficiency & Productivity

The following is a summary of remarks I made to the Clearwater (FL) Bar Association Solo & Small Firm Section on Tuesday, April 10, 2012 at the Greek Town Restaurant in Clearwater.

My wife’s friend, Christina, is enrolled in the Executive MBA Program at University of Tampa.  A few weeks ago, on a Saturday, Christina called to see whether I would mind reviewing her accounting homework.  We spent a couple hours going over the problems.  A few days later, she called again to schedule time the following Saturday and asked whether five classmates could tag along.  This began my adjunct-adjunct teaching career – think “off-off Broadway.”

A Business Case Study
After our most recent study session, I posed a hypothetical business case to my MBA group:

·        Imagine a business with leaders who have minimal, if any, formal business training.  Further assume these leaders act in a leadership capacity only part-time; most of the time they are indistinguishable from any other employee of the business.

·        Every employee operates with a high degree of autonomy and wears many, many hats – acting as his/her own marketing manager, sales director, scheduler, production department, quality control inspector, credit manager, billing department, and collection agent. 

·        The business delivers lots of different products; each product tailored to the customer’s unique needs.  Product quality depends largely on each customer’s special circumstances and the employee’s production skills.

·        Pricing, too, is tailored to each customer’s situation.

·        Fortunately, demand has remained brisk for a number of years; more than enough to absorb new competitors entering the marketplace.

·        Then things begin to change!

o   First, prohibitions on advertising are relaxed and, to keep pace with direct competitors, a big, new expense item is introduced to the budget.

o   Second, the economy hits bottom and suddenly demand for these products drops; there is an industry-wide slump and competition changes from friendly to intense.

How, I challenged these future MBAs, should the leaders of this business respond to ensure survival?

MBA Recommendations
By now, you have figured out I was describing the legal industry and the challenges we’ve undergone in recent years.  The MBAs had yet to be exposed to service organizations, but that didn’t constrain them from making recommendations fast and furious.  Their advice: the business needs to move quickly, guided by detailed financial analysis to:

1.      Assess their cash flow requirements to see how much time and what financial resources they have to weather the situation;

2.      Examine financial strengths and weaknesses of various product lines to figure out which are profitable and which to discontinue; and

3.      Reduce their operating costs while at the same time increasing efficiency and productivity.

I thought the MBA students were spot on in assessing the situation and how to react.

How Most Law Firms Actually Reacted
Apparently most law firms didn’t get this type advice.  Instead, most of them did the following:

1.      The boldly cut back on perks, like free soda, in an effort to maintain gross margins.

2.      When that proved insufficient, back office staff was reduced and later underproductive lawyers were jettisoned.

3.      Finally, they attempted a Hail Mary pass – turning to business development consultants in hopes that given enough training everybody might miraculously become a rainmaker.

Most law firms reacted with short-term responses to what is clearly a long-term challenge.  When the US economy comes back, we won’t be able to simply hit a reset button and return to business as usual circa 2007.  Gone forever are the days when firms can deal with financial challenges simply by raising hourly rates with impunity.

The Innovative Few
However, there are a few, an innovative few, big law firms deviating from the pack.  These firms are channeling my MBA students by doubling down on two back office activities – finance and technology. 

In years past, big law firms exiled their finance and technology teams to lower floors or separate buildings, rarely permitting them to interact with the lawyers, keeping them unseen and unheard except in reply to a specific question or complaint.  These innovative firms no longer view finance and technology simply as cost centers.  Their finance and IT resources are moving front to drive increased efficiency and productivity.

This new innovative efficiency and productivity focus can be capsulized into three broad categories:

1.      Outsourcing – to reduce costs and boost back off productivity;

2.      Practice Management – to increase lawyer productivity; and

3.      Financial Analysis – to improve profitability of lawyers, clients and matters.

The law firms are motivated by a concern that if they aren’t among the first to become more efficient and productive and someone else beats them to it, that other firm will end up eating their lunch.  It is a simple Darwinian matter of adapting and evolving to stay atop the economic food chain.

There is a business in Fargo, North Dakota which has become one of the city’s largest employers.  It’s not a high-tech venture; in fact, it performs among the lowest tech services you might imagine.  They do typing.

This company performs overflow typing services for more than 30 of the AmLaw 100 law firms.  Whenever a long document is heavily edited, the marked-up version is transmitted to Fargo and one of the 400+ typists employed there performs the typing changes.  This work used to be performed by in-house personnel staffed for peak deadline demand and woefully underproductive most of the time.  In contrast, the Fargo company has higher demand and is able to manage flexible work hours to meet the ebb-and-flow of its many customers.  Not insignificantly, the labor costs in Fargo are significantly lower than any place where these AmLaw 100 firms have offices.

Another outsourcing example involves London-based CMS Cameron McKenna.  Last year, this 1,100-lawyer firm outsourced its entire “middle office” employees to a company who is now responsible for all mid and lower-level accounting, IT, library, office facilities and photocopy personnel and resources.  The contract between the law firm and outsourcer is reportedly worth $856 million over 10 years.

Another example of outsourcing is from personal experience.  At Jenner & Block, I inherited a dysfunctional IT operation; the “gang that didn’t compute.”  The newly recruited IT director and I quickly concluded she could focus all of her energies executing a new technology delivery strategy to support the lawyers or become a full-time recruiter to obtain the support staff needed to accomplish the former; she couldn’t do both.  We decided to outsource the staff to an independent IT company who hired our people, replaced those whose skills didn’t match the job and provided new career path opportunities for those who remained.  The independent company became responsible for all daily IT work routines.  If three help desk techs called in sick the same day, it was their responsibility to staff the call desk; and when we needed a Cisco networking black belt to resolve a one-time in-a-million problem, they had resources in their bullpen to fix our crisis.  Outsourcing this function was one of the best decisions of my career because it freed-up my time to focus on other, more pressing issues.

Business consultants advise leaders to identify and off-load non-core tasks which can be performed by as well-or-better, for the same cost-or-less by someone else.  This liberates managers to give their full attention to things that really matter – those activities impacting customer service and revenue generation.  This is the business case for outsourcing the law office back office.

The three outsourcing examples cited have the following things in common.  The law firms received:

1.      Better service from the outsourcer, able to incorporate industry “best practices;”;

2.      Lower operating costs, because the outsourcer is in the business of providing these services using a non-law firm business model; and

3.      More time to focus on other, more important things directly impacting the firms’ revenue-generating activities.

Practice Management
I trace the history of efficiency and productivity in the legal industry to an event in 1993.   Prior to that date, law firms cared only about the billable hour with time reducing—productivity enhancements viewed as a threat to partner income.  Productivity to help meet deadlines was good; anything likely to reduce billable hours was bad.

Then in 1993 a Chicago lawyer named Fred Bartlit made a remarkable announcement.  A senior equity partner at Kirkland & Ellis, Bartlit announced he was leaving that venerable firm to establish a new kind of law firm – a firm who would charge clients for the “value” of work performed, not by the hour.  Bartlit’s press release was the first formal shot-across-the-bow attacking the billable hour.

Bartlit’s new law firm did not cause the demise of the billable hour, but it got corporate clients thinking about their economic relationship with outside counsel.  Nearly 20 years later, the billable hour is still alive, albeit weakened.  Today, most corporate legal work is still performed on a billable hour basis, but the economic slump has tilted the power base in the corporate client-law firm relationship in favor of the client.  “Value billing,” “alternative fee arrangement,” “fixed fee with success bonus” are now all the rage.

At 4L Law Firm Services we are working with a firm who last year decided to expand their nascent family law practice by advertising uncontested divorces on a fixed fee basis.  Almost immediately, the number of family law cases increased.  However, despite the uptick in new cases, the partners’ net income was no greater than it was a year earlier.  They turned to us to help them figure out what went wrong.

Examining their books we quickly noted the firm hired an additional paralegal to help with the additional case volume, staff overtime increased significantly, recorded billable hours declined since timekeeping on the fixed fee matters was deemed unnecessary, and the volume of commercial and employment litigation had declined from prior years’ levels.

We convinced the firm to experiment with timekeeping over a 2-month period.  Every timekeeper was asked to account for a minimum of 7.5 hours a day – client time and non-client time activities.  From this data we concluded the law firm:

1.      was earning less than half the amount they would have billed on the fixed fee matters if hourly rates had applied; and  

2.      was spending practically no time involved in the community, doing the types of relationship-building marketing that formerly produced the lucrative commercial and employment defense work that used to be their practice staple.

It was a classic tale.  The fixed fee uncontested divorce work crowded out the high value commercial and employment litigation.  Everyone was working harder for less money.

Since this analysis, timekeeping has now become mandatory at the firm – a minimum of 7.5 hours per day – regardless of the fee arrangement on any matter and including their non-client time activities.  Non-client time has been rechristened “investment time.”    We set up a series of pseudo investment time clients with names like chamber of commerce, bar association, community bank, and XYZ auto dealership.  The partners give one another investment time assignments, treating those assignments with the same urgency and deadlines as client work.  Their goal is to make sure sufficient time is devoted to non-client activities likely to generate more profitable work and thereby reduce the volume of lesser remunerative matters.

With respect to the billable assignments and “shadow billable value” on the fixed fee matters, we are helping the firm identify opportunities to become more efficient.  Increased efficiency and productivity is what Practice Management is all about.  [One large AmLaw 100 law firm is going so far as to hire non-lawyer managers with black belt status in Six Sigma management techniques to flow chart every aspect of client-lawyer relationship and how every litigation and transactional assignment is performed.  This firm hopes not only to become the most efficient large law firm; they also want corporate America to know they have adopted a corporate approach to how legal services are performed.]

4L Law Firm Services is working with the law firm to fully embrace Practice Management.  Among the things we are doing with them:

1.      Establishing a database template for each area of law – e.g., family law; commercial litigation; auto accident cases; employment litigation.  We are using the firm’s client intake interview form as the starting point to organize the facts of each case.

2.      Designing procedures to scan every piece of incoming mail so that case-specific communications can be linked to the case database.

3.      Using document management software to link every document generated within the firm, every email sent or received, pertinent PDFs and court filings, case research and eventually voicemail messages to the case database.

4.      Linking relevant contact information from the firm’s main contact list to the specific case database where it can be enhanced to reflect each party’s role.

5.      Enabling calendar/docket appointments to be linked to the case database.

6.      Providing the ability to generate electronic task/to-do lists to the case database.

7.      Delivering a document assembly interface so first drafts of documents can be selected from a forms library and linked to the specific case where the case caption and case-specific names and facts can be automatically inserted into the form, even adjusting pronounces to he, she or it and his, her or its.  Cutting and pasting is inherently inefficient as compared to document assembly applications.

The whole purpose of Practice Management is to make lawyers and staff more efficient and productive by organizing everything relevant to a specific case in a single, logically organized digital location, so lawyers can spend more time lawyering and less time searching for and grinding out paper.

Budgeting/Cash Flow Management
There’s a Boston comedian named Steven Wright who asserts, “Everyplace is within walking distance if you have enough time.”  Unfortunately, in business, as in life, there seldom is enough time and it is helpful to have a roadmap to periodically gauge your progress and consider alternatives.  In business this roadmap is a budget and regular financial projections and cash flow estimates serve to provide the periodic progress checks.

4L Law Firm Services is working with another law firm who had a fantastic 2011.  The number of lawyers increased by nearly 40%; they moved into larger, more luxurious space; they took on two significant contingency cases which continue to look like real winners and billable hours were up significantly year-to-year.  In hindsight, it is fair to say the firm did not make a single bad decision in 2011 – except they neglected to budget.  Without a budget, firm leadership was unable to measure the cumulative impact of their management decisions. 

At year-end, the firm’s leaders were surprised upon learning the bonus pool was lower than the preceding year.  More importantly, this information came to light too late to properly manage the other partners’ bonus expectations.  We currently are helping this firm to put together its first ever budget even though today’s date is April 10th.  It’s never too late to budget or make cash flow projections.

Over the past half hour, we discussed the crazy business model which subsumes the practice of law.  We also touched on outsourcing, improving efficiency via practice management tools, and the importance of budgeting and cash flow management.  The point is this: ongoing economic pressures are forcing law firms – big and small – to change our business model.  No one believes we’ll ever go back to practicing law the way it was before 2008. 

The largest law firms are spending more than $39,000 per lawyer each-and-every year on improving their financial back office to manage their law firms better and to upgrade their technology resources by which lawyers organize and execute their daily work.  The comparable spending on financial and technology resources at smaller law firms – those ranging in size from solo practitioners to 20-some lawyers – averages less than $11,500 per lawyer per year.  Large law firms are outspending you by more than 3-to-1 in the race to achieve greater efficiency and productivity and outpace the competition for the best clients and best talent.

Notwithstanding the 3-to-1 spending disadvantage, there is good news to report.  Small and midsize firms no longer require large firm budgets to access large law firm financial and technology resources.  For one thing, smaller firms can make quicker decisions – there are fewer egos involved to weigh in on decisions big and small.  Secondly, both outsourcing and advances in private cloud computing options can provide large law firm resources at a sliver of the cost of bringing those resources into your office on a full-time basis.

Large firms are focusing on efficiency and productivity because they see no other option but to do so.  Small and midsize firms are no less immune from the same pressures.

Friday, April 6, 2012

Audit Management Representation Letter

Parsley Sage Rosemary & Ginsburg llp
“always a reasonable result for a reasonable fee, always”

Learned H. Sage, Managing Partner
Mike Marget
April 6, 2012
The Auditors are Coming!  -- Management Representation Letter

Good News.  The auditors have substantially completed their work and have concluded that no adjusting journal entries are required to the books for the year ended December 31, 2011. 

They did offer one proposed adjusting entry – which I talked them out of.  It is the same suggestion they make every year – we should set aside a $25,000 reserve for possible uncollectible client costs advanced.  This proposed entry would reduce firm income by $25,000 and reduce the net assets by a similar amount.

I oppose the proposed entry (for the same reasons as in prior years) – it serves no real purpose.  Even conceding that $25,000 of our client costs advanced will not be collected next year, we recognize the cost write-offs as they occur.  Moreover, we manage our accounts receivable diligently and attempt to collect as much as possible and timely write-off amounts which grow old and appear uncollectible.  Finally, this $25,000 reduction of net income is not deductible for tax purposes – so there is no tax rationale for doing so.

Frankly, this entry has become a game with us.  They propose it; I reject it.  They get to make the point that they are doing their job, but because the amount is not material, I get to reject it thus putting them in their place.  It’s okay.  This item will undoubtedly be discussed again at the Final Meeting with the Auditors.

Attached is a draft copy of the financial report – income statement, balance sheet, cash flow statement (as well as subsidiary reports showing changes in partners’ capital accounts), together with the auditor’s written opinion.  Also attached is a copy of the Management Representation Letter which the firm must provide to Beane & Beane before everything is completed.  So you know, pursuant to the firm’s loan agreement with Big Bucks Bank, we need to provide the bank with a copy of the financial statements and audit report on or before April 30th. 

As to the Management Representation Letter, the language (as in prior years) is what Beane & Beane asks us to attest to or represent to them.  It states that we have not withheld any pertinent financial information from them and lists any number of things we do and don’t do – just as we have told them – but they want it in writing. 

It is customary for the Management Representation Letter to be signed by the law firm’s chief executive officer, chief operating officer (Administrator) and chief financial officer.  I am prepared to sign it and to go over any questions you may have prior to you signing it.

The date of the letter corresponds to the date Beane & Beane substantially completed their work on this year’s examination of the financial statements.