Module 1
How a firm makes and loses money: revenue, costs, profit and the leaks in between
Most lawyers are trained to do legal work and not to read a set of accounts. They can tell you precisely what a clause means and not whether the firm made money last quarter. Yet a firm that does not understand its own finances makes decisions in the dark: it hires when it should wait, discounts when it should hold its price and discovers a cash crisis when the bank writes. This first module sets out the basic picture: how a firm earns revenue, what it spends, what profit means and what it hides, why the mix of senior and junior effort (leverage) matters and where money leaks away between work done and money banked. It uses invented figures and plain language. The rest of the course builds on it.
Hover over an idea to light up what it connects to, click it for its definition, minimum requirements, an example and the usual trap, press Play to watch the map build step by step, or trace a short case through it.
Simplified teaching map, in general terms. Check the law where you work. On a small screen, scroll the map sideways.
By the end of this module you can
- Explain how a firm earns revenue.
- Separate fixed and variable costs.
- Read profit and margin.
- Understand leverage.
- Find the leaks between work and money.
Part 1. The lecture
How a firm earns revenue
A firm’s revenue is what it bills for its work and collects. The ways of earning it are few.
| Model | How revenue arises | What drives it |
|---|---|---|
| Hourly billing | Time recorded × rate, billed to the client. | Billable hours, rates and the share of time that is billed and paid. |
| Fixed or capped fees | A set price for a defined piece of work. | The number of matters, the price and how efficiently each is done. |
| Retainers and subscriptions | A regular payment for access or a package of services. | The number of subscribers and the cost of serving them. |
| Contingency or success fees (where lawful) | A share of what is recovered, or a fee if the case succeeds. | Win rate, case selection and the time of payment. |
| Other income | Referral income where lawful, training, publishing, interest. | Usually small, and regulated in some places. |
A firm often uses several. What matters is that for each you can say what the unit of revenue is, what it costs to produce and when the money arrives. The Matter Economics and Pricing course looks at the pricing of an individual matter. This course looks at the firm as a whole.
Costs: fixed, variable and the people
| Kind | Examples | Behaviour |
|---|---|---|
| People costs | Salaries, employer taxes, pensions, benefits, training, recruitment. | Usually the largest cost, often over half of revenue. Mostly fixed in the short term. |
| Premises | Rent, rates, utilities, cleaning, security. | Fixed, often long-term. |
| Technology and systems | Software, hardware, security, subscriptions. | Fixed, rising with headcount. |
| Professional costs | Insurance, regulatory and professional fees, accountancy and audit. | Fixed, with some variation with size. |
| Marketing and business development | Website, events, directories, advertising. | Discretionary, and often cut first. |
| Variable costs | Disbursements you advance (court fees, experts, travel), temporary staff. | Rise and fall with the work; recoverable from clients if properly agreed. |
Because most costs are fixed in the short run, a firm’s profit is very sensitive to revenue. If costs are 80 per cent of revenue and revenue falls by 10 per cent, profit does not fall by 10 per cent; it falls by half. That is why a quiet quarter hurts so much, and why a firm should know its break-even point (as in the Firm Break-Even Calculator of the Starting a Law Firm course).
A worked example (invented)
A firm bills 1,000,000 in a year. Costs are 800,000, of which 700,000 are fixed. Profit is 200,000, a 20 per cent margin.
If revenue falls 10 per cent, to 900,000, variable costs fall a little (say to 90,000 from 100,000), so costs are 790,000 and profit is 110,000. Revenue fell by a tenth and profit by almost half.
Profit and margin, and what they hide
Profit is revenue less costs for a period. Margin is profit as a percentage of revenue. They are the figures that partners ask about, and they are easy to misread.
- Profit on paper is not cash. Work that is billed but not paid counts as revenue in many accounts, yet the bank balance does not rise until the money arrives (Module 3).
- Owner’s pay. In a firm owned by those who work in it, profit is what remains after paying staff but often before paying the owners. A firm that shows a good profit may be paying its owners very little per hour, once their own time is counted.
- Depreciation, one-off items and accounting choices can move profit between years. Ask what is included.
- Profit per partner or owner is a common measure, and depends on how many there are and how work is shared.
- Margin is not the only measure. A small firm with a lower margin and a high take-home for the owner may be healthier than a large firm with a high margin and a stretched team.
Read a simple income statement as a story: how much came in, what it cost to deliver, what overheads were, what was left. Compare it with last year and with the budget, and ask why each large difference arose.
| Line (invented, in thousands) | This year | Last year |
|---|---|---|
| Fees billed | 1,000 | 900 |
| Less write-offs and discounts | (80) | (50) |
| Revenue | 920 | 850 |
| People costs | (560) | (500) |
| Premises | (80) | (80) |
| Technology and other overheads | (110) | (95) |
| Operating profit | 170 | 175 |
In this example, revenue rose by 8 per cent and profit slipped. The reasons are visible: write-offs rose by 30, people costs by 60 and overheads by 15. A manager would ask why write-offs rose and whether the extra people have produced extra income.
Leverage
Leverage is the ratio of junior to senior effort. A firm in which each partner leads a team of several associates and paralegals has high leverage; a firm of lone practitioners has none.
- Why it matters: a junior’s time costs less than it is billed for, and the difference contributes to profit. A partner who delegates well makes more from a matter than one who does everything.
- The limits: leverage works only if the juniors are busy, billable and supervised. Idle juniors are a cost; badly supervised juniors are a risk.
- For a small firm: the first hire is often a leverage decision. A paralegal or junior who does routine work frees the owner for work that earns more and cannot be delegated.
- Technology can act as leverage too: templates and automation (see the Legal Engineer Program) allow the same people to handle more matters.
Leverage must be matched to the work and to clients’ willingness to pay: clients may refuse to pay for training time, and some work cannot properly be done by juniors.
The five leaks
Between the hour of work and the money in the bank lie five places where value leaks away. Most firms lose more than they realise.
| Leak | What happens | A remedy |
|---|---|---|
| 1. Unrecorded time | Work is done and not recorded, so cannot be billed. | Record time daily; review work in progress; use prompts. |
| 2. Poor scoping | Fixed-fee or capped work takes far longer than priced, with no change process. | Scope carefully; record assumptions; agree changes in writing. |
| 3. Discounts and write-offs | Bills are reduced or not issued to keep the client happy or because the work was inefficient. | Set a write-off policy; require approval; learn the cause. |
| 4. Slow billing | Work sits unbilled for weeks or months. | Bill monthly or at milestones; a rule that bills go out within days. |
| 5. Slow or no payment | Clients pay late, or never. | Money on account, clear terms, credit control (Module 4). |
A rough measure of the combined leakage is the realisation rate: the share of the standard value of time recorded that is eventually collected. A firm whose realisation is 80 per cent is losing a fifth of its potential income to leaks. The next modules look at how to find and plug them.
A question to put to any firm
Of every hundred pounds of work done, how many are billed, and of those, how many are paid, and how long does it take? If nobody can answer, the leaks are unmeasured, and what is not measured is rarely fixed.
Part 2. Lab: Where Is the Leak?
Match each symptom to the leak it points to.
Situation 1 of 6
A lawyer remembers on Friday afternoon that she did four hours of work on Tuesday that is on no time sheet.
Where does this belong?
Part 3. Lab: Read the Statement
Choose the best reading in each case.
Situation 1 of 3
In the example statement, revenue rose 8 per cent but profit fell slightly. A partner says, ‘Revenue is up, so we are doing better.’
What is the best response?
Part 4. Lab: Spot the Money Myth
Click the statements about firm finances that are wrong or dangerous.
Things said in a partners’ meeting
Click every sentence that causes a problem, then press Check. There may be 4 problems, and some sentences are fine.
Part 5. Check your understanding
Ten questions drawn from a larger pool. Sign in to have your score saved towards your certificate.
You have finished the free module
Here is what you can do now, and where the course goes next
Module 1 gave you
- Explain how a firm earns revenue.
- Separate fixed and variable costs.
- Read profit and margin.
- Understand leverage.
- Find the leaks between work and money.
Next, 6 more modules and a capstone
- Module 2: Pricing policy and billing: rates, discounts, fixed fees, bills and what clients are toldYou will learn to set a rate card and know what it is for.
- Module 3: Cash flow and working capital: why profitable firms run out of moneyYou will learn to describe the cycle from work to money.
- Module 4: Getting paid: terms, money on account, credit control and difficult debtsYou will learn to make payment likely before work begins.
- Module 5: Budgets, targets and management accounts: planning the year and watching itYou will learn to build a budget from the bottom up.
- Module 6: Tax, reserves, drawings and profit-sharing: what happens to the profit
- Module 7: Controls, risk and resilience: protecting the firm’s money and its future
- Capstone: Capstone: diagnose and fix an invented firm’s cash problem
Each module has its own practice labs and a graded quiz, and a Certificate of Completion follows when you pass them all. The whole course is $15 once, or included in an All-Access Membership.
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General education on law-firm finance, using invented firms and figures. It is not accounting, tax, financial or legal advice. Rules on accounting, tax, client money, insurance and fees differ between countries and change: take advice from a qualified accountant and check your regulator’s current rules.
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