Professional Services Accounting ARTICLE -

More Profit, Less Loss

Point Associates to the Bottom Line

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

When you hire associates you expect them to bring new skills and energy to your firm, allowing you to expand capacity and grow. But associates cost money. Some experts estimate that it takes three to five years for law firms to break even on their investment in a new associate.

Although your associates’ first priority is legal work, they also need to be aware of your firm’s investment in them. One way you can do this is by creating a formal leadership training program to teach associates how to think like business owners. But perhaps the best way to turn associates into fiscally aware members of your firm is to have them create individual profit and loss (P&L) statements.

Reducing billable time

Like any P&L statement, the individual version starts with revenues. In this case gross revenue equals the associate’s billable time.

Billable time must be reduced by several items, including write-offs. Gross revenue (billable time) – write-offs = net revenues. Your time and billing system software may assign specific write-offs against an associate’s time or perform a general markdown of time against everyone who worked on a particular engagement. Less sophisticated systems may use a blended or average write-down percentage based on practice areas or the firm’s overall write-down percentage.

Billable time is also reduced by direct costs, including an associate’s:

• Salary,
• Benefits,
• 401(k) plan matching contributions,
• Dues,
• Car allowance, and
• Payroll taxes.

Direct costs also might include individual expenses that typically aren’t passed on to clients, such as nonbillable portions of monthly cell phone bills.

Overhead per timekeeper

Associates also must reduce billable time by overhead allocations. One method of doing this is known as the “overhead per timekeeper.” A timekeeper usually is defined as someone whose primary purpose is to work on client matters — partners, associates and paralegals.

Overhead expenses generally equal total expenses less the direct expenses allocated to timekeepers (salary and benefits). They normally include rent, business and liability insurance, support staff, office supplies, computer software, postage, delivery, subscriptions, research database fees, and other expenses needed to keep a firm operating.

The total operating expenses are then allocated to the timekeeper using the full-time equivalent (FTE) allocation system. Many firms do this by assigning an FTE of 1.0 to associates, 1.5 to partners and 0.5 to paralegals, but your firm can customize the equation. Add up the number of FTEs and divide it into the total overhead expenses; then multiply, for each timekeeper, that result times their respective FTE number.

Take, for example, the fictitious firm Sullivan James Greenberg (SJG). The firm has five partners, 12 associates and seven  paralegals. This gives them FTEs of 23, or (5 × 1.5) + (12 × 1.0) + (7 × 0.5) = 23. If the firm’s overhead expenses total $900,000, the allocation to an associate would be $39,130 [($900,000/23) × 1].

Sample statement

Sarah Fuller, a second-year associate at SJG, billed 1,800 hours in 2010 at a rate of $200 per hour. The firm wrote off 15% of her gross work-in-process. Her salary was $120,000 with a 10% bonus, and benefits and payroll taxes equal 20% of her salary expense (before bonus). As previously shown, SJG’s overhead expenses were $900,000 for the fiscal year.

So Sarah’s P&L statement would look something like this:

Revenue

Gross revenue from billable time                       $360,000
Less work-in-process write-offs                           (54,000)
Net revenue                                                     $306,000

Direct costs

Salary and bonus                                             $132,000
Benefits, payroll taxes and other direct costs         24,000
Total direct expenses                                       $156,000

Gross profit attributable to Sarah Fuller              $150,000
Less overhead allocation                                   (39,130)

Net profit attributable to Sarah Fuller      $ 110,870

Eyes on the bottom line

Asking associates — and even partners — to create individual P&L statements can help attorneys see their financial role clearly. It’s common for associates to evaluate their performance and worth based on billable hours. But a P&L statement provides a more sophisticated and accurate view of the bottom line.

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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