January/February 2019

Finance

First Quarter 2019, Here We Come!

Peter Roberts

Your firm is using time and billing software and accounting software either in the cloud, on your computers in the office or maybe in both places. These tools, of course, are essential for knowing what’s going on in your firm. I recently assisted a personal injury firm whose lawyers and paralegals did not enter time on the matters despite having an excellent time and billing system. When I suggested the firm seemed to have too many staff in relation to the number of lawyers, a question arose about what the staff was doing that no one could answer. It wasn’t possible to know how busy the paralegals were. A billable hours report discloses this information. But beware the potential of TMI (too much information)!

Down With Big Data

I’m not a big fan of the data reports that time and billing software can produce. Data reports are the reports of individual transactions such as time entries, expenses paid or checks deposited. They are essential for understanding how an error occurred but are not meant to be distributed to your lawyers each month.

If the financial data are properly categorized, it’s possible to see a report of profitability by certain categories. A firm with two or more offices likely is using reports that categorize the transactions for each office under the particular office heading. That makes sense and may even engender a friendly rivalry between the supervising partners of each office!

Client Intake

The first step is at client intake. Client intake is a big deal in my opinion. The firm should follow standard procedures for how the client intake meeting is conducted. This includes how to properly turn away a potential client. For the clients who are accepted, all the lawyers should be familiar with the procedures, including using a checklist of topics to cover with each new client.

As you open the new matter in your software, think about what the software offers in terms of categorizing the matter. You may assign the new matter to a billing attorney, a responsible attorney, a department or an office. I like the idea of also assigning the new matter to a practice area. Does your time and billing software allow you to choose a practice area when opening a new matter? It certainly should.

Where Does This Take Us?

Once the matter is assigned to a practice area, each time entry of any timekeeper will show up on the matter, under the timekeeper’s name and on a report by practice area. Table 1 is what the practice area report might look like.

Estate planning sure is busy! Yes, the individual billable hours totals vary from a low of 917 to a high of 1,681. That divergence does not concern me because I am drawing a comparison between the billable time spent and fees collected. Now let’s examine the percentage composition for each timekeeper based on the hours billed within each practice area (see Table 2).

Next we allocate the compensation of each timekeeper to each practice area based on the billable hours devoted to that practice area, as noted in Table 3. For this purpose I include only payroll paid to each individual. Firms might assign nonbillable account numbers that timekeepers can use for vacation, firm activities, administrative tasks, etc. Such a column summarizing the nonbillable hours by timekeeper could be added. I have seen that the relative accuracy, consistency and completeness of those nonbillable hours vary widely, however.

Deriving Meaning From the Analysis

Assign the respective fees collected to each column by practice area and match the payroll compensation cost against the fees to derive a gross profit or a kind of “cost of goods sold” in accounting parlance. In this case we hope the estate planning practice is generating sufficient cash flow because about 40 percent of the payroll is being consumed there. A major fee may have been collected from 2017 or 2016 that would distort this analysis. Consider removing that fee from the total for that practice area for a more consistent comparison. Note the total compensation of $740,650. If we use the old-line Rule of Three, we hope the total fees collected are three times the compensation or $2,220,000!

The next step to consider is whether to use the percentages at the bottom of the table as a basis for allocating payroll-related costs, fringe benefits and other employee overhead. I believe it’s very important to avoid trying to be too precise. Differences of opinion likely will arise and will also arise as to the justification for allocating indirect overhead such as rent, administrative staff costs and insurance on this basis, as opposed to perhaps equally across all practice areas. Your certified public accountant may act as a trusted arbiter of such allocation methodologies.

I believe it’s important to know whether the “people cost” is not only being covered by the respective fees collected by practice area but also to know how wide the respective profit margins are. This analysis can become a tool to assess pricing strategies.

Keep it Under Wraps

Your bookkeeper can set up a spreadsheet to facilitate these calculations. This exercise should not leave your bookkeeper’s office, at least for now. Keep this information to yourself until you are comfortable with your understanding of the numbers, how the numbers change over time and you have ready answers for the questions your partners will throw at, er, ask you.

Even if a practice area is yielding a modest gross profit or yielding a loss, there may be good reasons that all of the partners share for maintaining the practice area so any defensiveness should quickly dissipate, particularly if you practice in a firm with an institutionalized and mutually supportive firm culture that is not siloed.

Peter Roberts

Peter Roberts is a private practice management consultant for lawyers. He is the former practice management advisor in the Law Office Management Assistance Program of the Washington State Bar Association for 13 years. He is active in the ABA Law Practice Division as co-chair of the Law Firm Finance Committee. Email him.

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