Calculating Your Client’s Lifetime Value
In the business world, cash flow is king. Depending on the kind of law practice you operate, creating a practice that can maintain a steady and stable cash flow can be difficult. If you have ever had lunch with me or spoken to me for any length of time about the hardships of practicing law, you would have likely heard me preach about the necessity of developing a practice that successfully manages the ebb and flow of cash.
If you asked me to identify the top 10 reasons that law firms fail, cash flow is in positions 1, 2 and 3! In simple terms, if you can create a practice with a positive cash flow, you have a stable and likely successful practice. On the other hand, if you have a negative cash flow, this is serious!
So, if you have been wondering how you can improve your cash flow, the answer may be simpler than you imagine. Well, not necessary simpler, but easy to understand. First, the best way to ensure that your practice maintains a positive cash flow is to understand some practice performance indicators (PPI), such as client acquisition metrics and the lifetime value of clients in your practice. These PPIs are long-forgotten business terms that lawyers rarely pay attention to or simply ignore.
Client Lifetime Values (CLTV)
Client lifetime values (CLTV) is exactly what it sounds like. CLTV is simply the total value (in dollars) that a client brings to your practice throughout the entirety of their relationship with your law firm. CLTV can vary drastically for different practices. Some practices, such as general practices or family law firms, can have extremely high CLTVs. Others, like personal injury and criminal law, typically have lower CLTVs. CLTVs vary due to the number of transactions involved, length of the transactions, likelihood of repeat transactions, alternative or related legal services, etc.
Why is CLTV Important to Your Practice?
CLTV is important to every business. While there are many metrics to measure business success by, CLTV stands out as one of the most important because of its critical role of calculating how important and valuable each client is to your practice.
Possibly the most interesting part of CLTV is that it measures what an average client is worth to your practice. This is incredibly helpful when attempting to manage your practice’s cash flow because your CLTV will give you an idea of how much you should be spending to acquire new clients. As such, when you understand your CLTV and you control your expenses for client acquisition, you will likely have a strong positive cash flow.
How Do You Measure CLTV?
To understand how CLTV is measured, it is important to understand exactly what CLTV is. CLTV is often described as a prediction of the net profit attributed to the entire future relationship with a customer. This means that calculating the CLTV for your practice will likely involve some educated predictions. Please do not undertake your CLTV and manage your cash flow with guesswork.
Steps to Calculating Your CLTV
Step 1: Estimate the average customer lifetime.
Step 2: Estimate the total future revenue of your average client.
Step 3: Calculate the average costs of practicing in your particular practice area, and include advertising expenses to acquire the clients.
Step 4: Calculate the net value of the future earnings. (I do not use net present value as it needlessly complicates the process for most small practices).
Finally, the last thing to do is to crunch the numbers and calculate the CLTV for your practice. I would recommend doing this first with old clients and cases so that you can better understand the results.
Calculate Net Profits (NP):
Net Profits = Total Cost (Step 3) minus Total Revenue (Step 2) Calculate Net Lifetime Value
Divide Net Profit for your average client by their average lifetime (in years, CLT) to calculate the Net Lifetime Value in Dollars per Year (NV/Yr).
NP / CLT = NV/Yr. Calculate the Client Lifetime Value (CLTV)
The final step is to calculate the CLTV by multiplying Client Lifetime Value (CLT) from Step 1 by the average Net Lifetime Value (NV/Yr.)
Average CLT (in years)* Average NV/Yr = CLTV ($)
There you have it. The math is incredibly simple, and now you know what your client’s lifetime value is. Regardless, I hope that this information helps you come up with a better understanding of how to manage and handle your practice’s cash flow. If you read this and it doesn’t make sense, don’t panic. Simply contact me using the information below, and we can schedule a lunch and crunch the numbers and discuss the concept together. There is no reason that we can’t figure this out together.
Jared Pierce hung his own shingle right out of law school and has spent every minute since then discovering the joys and difficulties of chasing success. Anyone who has ever met Jared will tell you h