Professional Services Accounting ARTICLE -

Measuring per-attorney overhead

Target Audience: Legal Professionals, Professional Service Firms, Law Firm Partners, Law Firm Accounting, Law Firm Marketing Directors

Successful law firms closely monitor their revenues and profitability, both firmwide and by attorney. But the need to allocate overhead can make it difficult to truly assess per-attorney profitability, thereby undermining compensation and related decisions.

Many firms simply divide total overhead costs by the number of attorneys. But savvy firms take steps to allocate direct and indirect overhead more accurately.

The basic components

To properly allocate overhead, you must consider every employee who generates billable time, including paralegals. Further, you need to break down expenses into direct and indirect overhead.

Direct overhead encompasses expenses that can be directly connected to a staff member. Examples include salary, payroll taxes and employee benefits and perks.

Indirect overhead includes those expenses that can’t obviously be assigned to specific individuals, such as rent, utilities, insurance, staff salaries and technology costs. In other words, indirect overhead covers all of the costs that remain after the direct overhead is deducted from total expenses.

Weight it out

So how does a firm allocate its indirect overhead? One way is to employ a weighted system that assigns individual revenue-generators a weight based on the percentage of total resources they use.

A partner, for example, may have a full-time secretary, while an associate shares a secretary, and a paralegal has no access to a secretary. The partner obviously consumes more support staff resources than an associate, and an associate consumes more than a paralegal. Thus, the system might assign a weight of 1.5 for partners, 1.0 for associates and 0.5 for paralegals. The weights can be adjusted as needed, so that, for instance, a long-tenured senior partner has a greater weight than a junior partner.

After the appropriate weights are established, the indirect overhead is divided by the total weight of the firm to arrive at a per-unit figure for the indirect overhead. Each individual’s weight is then multiplied by the per-unit figure to calculate the indirect cost for that person.

To illustrate, suppose a firm comprises two partners, three associates and one paralegal, with the weights assigned as above. The total weight for the firm, therefore, is 6.5. If the firm’s indirect overhead is $130,000, the per-unit overhead equals $20,000. As a result, the firm will assign indirect overhead of $30,000 to each partner, $20,000 to each associate and $10,000 to the paralegal.

From here to profitability

The formula for an individual attorney’s profitability is typically expressed as:

Billings – (Indirect + Direct overhead) = Net profit

But most firms use their associates to generate more revenue than their overhead; the difference creates additional income for the partners.

Making it all work

As a firm leader, make sure you keep the disparity described above in mind when relying on the profitability data for decision-making. In general, however, a weighted system helps law firms capture more accurate per-attorney overhead and profitability figures. Consult your Professional Services Accountant for analysis and guidance on assigning appropriate weights.

Find out how our expertise in professional services accounting can add value to your business. Email us or call us at 1 (888) 875-9770.

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