Well-managed law firms pursue a long-term strategy, but budget carefully in the short-term, usually with an eye on a realistic potential profit for the partners. That profit of course is the difference between the firm’s revenues and its expenses. In my last article, I created a hypothetical expense budget for a law firm with five attorneys and a 10-person support staff. The categorical breakdown is below for your convenience:
These expenses provide the resources that, together with the skills and reputations of the partners, will generate the firm’s revenue over the next 12 months. Now, it is important to determine as precisely as possible the likely range of those revenues in order to project the firm’s profit. Begin by determining the market rate for each timekeeper’s services. While there are attorneys in large markets capable of billing $1,000+ per hour, that rate is not realistic for the vast majority of attorneys. For attorneys, a typical billable range is $250-$600. Average billing rates for paralegals range from $75-$150 per hour in small to midsized firms and can easily range from $200-$300 in large firms. The ranges for attorneys and paralegals are based on the size of your firm, market and experience of corresponding personnel.
The next step is to determine how much time each person will likely work on billable matters. According to the 2012 LexisNexis Law Firm Billable Hours Survey attorneys only bill about two-thirds of the hours they work. If an attorney works 2,400 hours over the course of a year, he will bill around 1,600 hours. For your support staff, an hourly employee can work approximately 2,000 hours without being paid overtime. With respect to staff members who are primarily billing timekeepers, the firm should be able to have them work 1,600 hours on billable matters. Note that this percentage of hours worked on billable matters will greatly decrease if the staff members are requested to perform numerous tasks that cannot be billed to clients, which is where the value of secretarial staff and receptionists comes into play.
Consider our hypothetical firm which has five attorneys and 10 support staff. Assume that six of the staff focus on billable matters. This means the five attorneys and six paralegals may be able to bill 1,600 hours per year for a total of 17,600 hours. The chart below is an example of how revenue and margins can be calculated per employee:
Since realization rates range between 80-95 percent for most law firms, plan conservatively and assume your realization rate will be 85 percent. If the firm generates $3,184,000 in potential revenue, then the estimated realization is $2,706,400. After subtracting the $1,500,000 in expenses, the firm is projected to generate $1,206,400 in profit. Of course, a number of factors can affect the projections. For example, if your firm has unexpected costs, is not able to generate 1,600 billable hours per attorney or paralegal, or has a realization rate less than 85 percent, then your firm will be less profitable. If, however, your firm can control its expenses, bill more hours or achieve higher realization rates, profits will increase.
Understanding this process will enable you to better determine the value of hiring a new attorney or staff member during the year or even making the tough decision to terminate a position. By adding another billable employee, the average cost per billable employee would drop and could thus increase profits while letting a billing employee go could decrease profits or require an increase in the need for others to assume the billable work in order to make up the difference. The budget is thus a forecast and a target against which progress during the year can be monitored.
Firms that fail to budget and manage appropriately are unlikely to maximize their return on the work they do. The consequences are uncertainty and frustrations – results any law firm should try to avoid. Chris Vaughan