Business Performance:Financial Tools for Mediators

April 17, 2000

Introduction

No mediator can realistically hope to be expert in all aspects of management, particularly financial management; there is simply too much to know. But even comparative inattention to your firm’s finances can negatively impact its profitability. Consider an analogy. You know that over time your car’s gas mileage will tend to decline. And unless something drastic occurs, you’re likely to remain largely unaware or unconcerned about the decline. The same is true in mediation practices. A mediator who doesn’t regularly monitor the financial performance of the business is like a motorist who doesn’t get tune-ups, you can be sure your efficiency will slip. A 10% improvement in gas mileage is worth real money, what would a 10% improvement in the financial performance of your practice be worth?

My objective is to offer some tools to help you make that 10% improvement. First, I will present a number of concepts useful in performance evaluation, then discuss several means of evaluating financial performance. Finally, I will offer some tips on improving the financial efficiency of your mediation practice. One caveat, however. No single evaluative approach fits all situations. Indeed, I believe that more information is generally better than less, so my advice is to combine financial approaches, including the traditional financial statements.

Concepts

There are many financial concepts useful in performance evaluation, including:

Billing or charge rate: The amount charged per unit of service.

Billed, billable, and non-billed hours. Billed hours are those for which the client is actually charged, billable hours those for which the client could be charged, and non-billed are non-project hours.

Collection rate: For any given period and billing rate the collection rate equals dollars collected divided by dollars billed. For example, collecting $7,500 on invoices totaling $10,000 results in a collection rate of 75% ($7,500/$10,000.)

The collection rate may also be calculated using hours. For example, collecting the full amount on 85 of 115 billed hours gives a collection rate of 74% (85/115.) The hourly approach requires an adjustment for partial payments by converting them into hour-equivalents.

Calculating the collection rate is straightforward providing charges are uniform. But many mediators vary their charges. In such situations there are two basic strategies for calculating the collection rate:

Rate per charge method. You can calculate a collection rate (“C.R.” below) for each separate charge by dividing the amount collected by the corresponding amount billed:

Charge	Hrs Billed	$’s Billed	Hrs Collect	$’s Collect	C.R.
$50	50	$2,500	45	$2,250	90%
$75	30	$2,250	25	$1,875	83%
$100	25	$2,500	15	$1,500	60%
$125	10	$1,250	5	$625	50%
Totals	115	$8,500	90	$6,250

Average rate method. The average collection rate for a given period equals total dollars received divided by total dollars billed. In this example, approximately 74% ($6,250/$8,500.)

Fixed and variable costs: Fixed costs are those that remain relatively stable for a period of time, for example rent or salaries. Variable costs, such as office supplies, tend to fluctuate more readily with the level of business activity.

Operating rate: The operating rate is a measure of the portion of business “capacity” utilized in a given period. It is found by dividing billed hours by total hours. For example, 100 billed hours in a normal month equals an operating rate of approximately 60% (100/167.)

Receivables: Receivables are funds you expect to collect, typically resulting from services provided.

Track and analyze your time

Most mediators keep track of the time they bill on specific projects. But I would be willing to bet that most mediators have no idea how those billed hours relate to their billable, non-billed, and total hours. The relationships among the various components of your time are the data that makes it possible to evaluate financial performance.

To illustrate the basics of time analysis I have attached a sample time sheet and report. The time sheet is divided in columns recording the date, to and from times (the “start” and “stop” times for each activity), project code, total time, and a brief description of the activity. I prefer to record activities in increments of fifteen minutes, although other intervals may be used. The report allows you to track billed, billable, and non-billed time on a weekly, monthly, and year-to-date basis as well as track collection, operating, and efficiency rates. Coding your time is straightforward:

G is for general work, such as personal calls or filing.

M represents marketing activities.

J1 is the code for the Jones project. You can use the first letter of the client’s last name and a 1 to distinguish this client from another whose last name may also begin with a J. For example, the next “J” client, Johnson, would be coded J2.

With the information recorded you can add up and record the time for each activity and analyze it. In the sample day you can see the mediator worked a total of ten hours: three billed (or an operating rate of 30%), three marketing, and four general. An analysis of your time could include:

Time spent on each activity per period.

Month-to-date and year-to-date totals, and percentages of total, of each activity.

Totals and percentages as compared to prior periods.

Projected monthly or annual income.

Evaluation tools

Now we can combine financial concepts and time sheet analysis with a number of evaluation tools:

Billed time: One simple tool is tracking total billed hours in a given period. This method works best if your collections are predictable and timely. One drawback of this approach is the fact that cash flows are not always immediate or uniform. Another is that it is far from comprehensive, as it does not include billable and non-billed time.

Financial statements: Periodic financial statements comprise the financial information system for many firms. They provide valuable information and generate the “raw material” for your tax returns. But many mediators are not trained to analyze financial statements or may not receive them frequently. Cost is another disadvantage. Of course, you could purchase accounting software, but you still need to know how set up the system, input the data, and read and analyze the output. But I believe the single greatest drawback to financial statements is that they do not report or analyze non-monetary information, information that can have a substantial impact on your business.

Profit maximization: This approach seeks to maximize profit by adjusting the billing rate. You know that, other things being equal, lowering your rate should increase business and raising it decrease business. At some point along the continuum of possible billing rates is the one that, taking into consideration a number of factors, maximizes profit. While this approach has much to commend it, there are so many variables that it is difficult for the average consultant to implement.

Target income: Here you set an income target for a specific period. For example, you might want to increase last year’s gross revenue by 10% from $100,000 to $110,000. Sub-targets can also be established for months or quarters. The trick, of course, is figuring out why your targets are or are not being met.

Efficiency rate: I believe the efficiency rate is a most valuable indicator of financial performance. It is found by multiplying the operating rate by the collection rate. For example, an operating rate of 50% and a collection rate of 80% equal an efficiency rate of 40%. The efficiency rate is useful because:

It reflects both billed and non-billed time.

It reflects the fact that cash flow is a function of business billed and bills collected.

If I had to pick one evaluation tool, in addition to financial statements, it would be the efficiency rate. It combines many aspects of business, is easy to calculate, flexible, and can be used in combination with other tools.

Improving your efficiency rate

Here are some tips on improving your efficiency rate:

Avoid free work: One of the best ways to improve your efficiency rate is to reduce your billable (“free”) hours. For example, you may not charge for all calls or the extra fifteen minutes in a mediation session. And how many free hours are built into your memoranda of understanding or other documents?

This raises the important point of “effective hourly rate” or the average hourly rate on a specific project including billed and billable hours. For example, on a recent project you billed for 10 hours at $100 per hour. However, your time sheet shows you also spent 10 billable hours on the project, for a total of 20 hours. This means that your effective hourly rate was not $100, but $50 ($100/20.) The impact of free work on revenue is often substantial, in this example $1,000.

Know your efficiency break-even hours and charge: Assume that your current monthly expenses are $3,600 and your efficiency rate is 40%. If your billing rate is $100 you must collect the equivalent of 36 hours to break even. How many hours need to be “worked” to gross the $3,600? The answer is 90 (total expenses divided by the efficiency rate, or $3,600/40.) These 90 hours are your efficiency break-even hours.

With your efficiency break-even hours in hand you can calculate your efficiency break-even charge, the amount you need to charge at a specified efficiency rate to cover your monthly expenses. In this case the answer is $40 per hour (total costs divided by the efficiency break-even hours, or $3,600/90.)

Knowing your break-even efficiency hours and charge can improve your efficiency rate by helping you make better pricing and work-time decisions. For example, if you charge $50 per hour and your break-even efficiency charge is $40 you know your typical “efficiency” profit margin is $10 per hour. This information can help you avoid bidding a job below cost. Knowing that you need to put in 90 hours per month is also useful, as it sets a minimum time requirement.

Ask questions: Ideally, your clients pay cash up front. If, however, you work in a less-than-ideal world, ask your clients’ some questions regarding their financial situation. Screening out, or altering your payment arrangements for, prospects with a high likelihood of default saves time, money, and aggravation.

Plan: Regular strategic planning sessions are a tremendous tool for setting goals and objectives.

Don’t undervalue yourself: Your effort, experience, and expertise have value. Why should your clients value those qualities highly if you don’t? Try to steer clear of:

Haggling. If you are frequently “adjusting” your rate downward you may be being perceived as weak or vacillating or overcharging for the market segment you are reaching.

A variation on this theme is asking clients what they are willing to pay. Does “willing” mean the lowest price they can get you to take, the price they think is fair, or the price they think the service is worth? The question is vague, implies you don not know the value of your own service, and puts the client on the spot.

Bidding a job below fixed cost. Many mediators think that working, even at below fixed cost, is better than not working. I disagree. Such jobs prevent you from utilizing the same time more productively. In other words, they have associated variable and opportunity costs. Not covering variable and opportunity costs can turn a marginally profitable or break-even project into a loser.

Established fees. There are environments where the charge is established by third parties, such as the court. You should periodically review your cost structure to make sure you are not providing such services below cost.

“Punch out”: A pilot who uses the ejection seat rather than ride the plane into the ground has “punched out.” Here punching out means bailing from a bad service situation. Sometimes, despite our best intentions or most adroit due diligence, things go sour. Watch out for some of the financial warning signs:

A change in the method of payment (for example, payments formerly made by personal checks are now made by third party checks, cash, or money orders.)

A growing interval between payments or skipped payments.

Bounced checks.

The client or the client’s employer declares bankruptcy.

The client wants to re-negotiate the fee.

The client’s employment status deteriorates.

I am not suggesting that you automatically terminate a relationship when warning signs appear. But some mediators feel what can only be described as a “moral imperative” to continue a project even when the situation has deteriorated beyond reasonable hope. While morality is admirable, the sense of obligation it engenders may transform the client’s problem into your problem. And once the problem has new ownership your ability to act is compromised.

You are not a bank: The longer you carry a receivable the longer you play banker, in essence loaning the client money. And since receivables are only as good as the integrity of the client, if things go bad the client will probably act in his/her interest, not yours. In addition:

Receivables require interest charges or other monitoring and servicing fees to compensate for delays in payment.

You may have to become a “collection agency.”

What’s that 10% worth?

When all is said and done, what’s that 10% increase in “gas mileage” worth? Let’s consider an example. Assume you work a normal month with an efficiency rate of 40%. In this situation your projected gross income is $6,666.80 per month. Not being satisfied with a 40% efficiency rate, however, you implement a new marketing program and tighten up collection practices. As a result, your efficiency rate increases to 50% and your monthly gross improves to roughly $8,333. Therefore, the 10% increase in your efficiency rate is worth $1,666.70 per month or about $20,000 per year.

It should be apparent at this point that changes in the efficiency rate have a substantial impact on revenue. In fact, each 1-% improvement in your efficiency rate represents $167, only 100 billed minutes, per month. How many 100-minute blocks are waiting to be discovered in your practice?

Of course, it’s not simply a matter of increasing your income, but the opportunities such an increase represents. Suppose each month for the next fifteen years you invested the $1,666.70 in your retirement account? You just bumped your retirement fund by nearly $700,000!

In Conclusion

I have heard it said on more than one occasion that mediation is, like the corner grocer of old, a “ma and pa” profession. And like the old grocer, many mediators have only a vague notion of how well their business is doing, much less how well it could be doing. Such an approach may work in a stable industry, one in which the competitive environment doesn’t fluctuate rapidly. But mediation is not such an industry. And as mediation becomes more competitive, as I believe it will, successful mediators will be those who combine a quality service with a quality business operation. Running a successful and efficient business takes more than luck. You need to hone your skills in acquiring, analyzing, and acting on information.

Applying the information you collect from your time sheets and billing system requires only a modicum of effort. The benefits it can yield are substantial, both in reducing wasted effort and increasing profitability. But perhaps the greatest benefit of all is to your clients, whose mediators are more focused and better organized.

APPENDIX A:

SAMPLE TIME SHEET

DATE	FROM	TO	CODE	TIME	DESCRIPTION
1-1-99	7:00	8:15	M	1.25	Breakfast with C. Brown: referrals
1-1-99	8:15	8:45	G	0.50	Analyze time sheets
1-1-99	8:45	9:00	G	0.25	Return call from bank
1-1-99	9:00	11:00	J1	2.00	Jones mediation: first session
1-1-99	11:00	11:15	G	0.25	—–
1-1-99	11:15	12:30	G	1.25	Bank, dry cleaner, lunch
1-1-99	12:30	1:00	J2	0.50	Discuss med. w/wife’s attorney
1-1-99	1:00	1:30	J2	0.50	Prepare Johnson (2) Med. Agreement
1-1-99	1:30	2:15	G	0.75	Phone w/Junior about grades
1-1-99	2:15	3:00	M	0.75	Meet with PR firm
1-1-99	3:00	4:00	G	1.00	Read business paper
1-1-99	4:00	5:00	M	1.00	Return inquiry calls

APPENDIX B:

SAMPLE TIME ANALYSIS REPORT

Week of: _______________ 1999 Prepared by: _______________

CODE	WEEK	% of Week	MONTH	% Month	Y.T.D.	% Y.T.D.

J1	2.00	20.0%	2.00	20.0%	2.00	20.0
J1 Billable	0		0		0
J2	1.00	10.0%	1.00	10.0%	1.00	10.0%
J2 Billable	0		0		0

Tot. Billed	3.00	30.0%	3.00	30.0%	3.00	30.0%

G	4.00	40.0%	4.00	40.0%	4.00	40.0%
M	3.00	30.0%	3.00	30.0%	3.00	30.0%

Totals	10.00	100.0%	10.00	100.00%	10.00	100.0%
O.R. ¹	30.0%		30.0%		30.0%
C.R. ²	100.0%		100.0%		100.0%
E.R. ³	30.0%		30.0%		30.0%