Professional Service Firms Articles
Getting Associates to Think Like Business Owners

Target Audience: Legal Professionals, Professional Service Firms, Partners, Business Owners

Industry consultants and managing partners estimate it takes three to five years for a firm to break even on the investment in a new associate. And with starting salaries at many large firms now topping $100,000, the profitability of each associate is more important in an individual’s career sooner than it ever has been.

Getting associates to realize how they impact your firm’s bottom line can actually be a positive thing. First, it helps associates appreciate the firm’s financial investment in them, which, in turn, can lead to more commitment to the firm. Second, it can give associates a clearer picture of what they need to do to become a profit center for the firm.

Gaining awareness takes time

Creating this awareness can be tricky. Consider a two-pronged program to help associates think more like owners:

Encourage all associates to create their own personal financial plan. This will help them establish and quantify personal goals and establish a need to succeed in the firm, and
Create a formal leadership training program to help them develop the skills to reach the partnership level.

Another way to create this awareness is with individual profit and loss (P&L) statements.

Creating an individual P&L

Like any P&L statement, the individual version starts off with revenues. In this case gross revenue equals the associate’s billable time. Billable time would then be reduced by:

• Write-offs. Gross revenue (billable time) less write-offs equals net revenues. Sophisticated time and billing systems 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.
• Direct costs. The next step is to calculate the individual’s direct cost to the firm. Direct costs include the associate’s salary, benefits, 401(k) plan matching contributions, dues, car allowance, payroll taxes and any other individual expenses that typically aren’t passed on to clients (the nonbillable portions of monthly cell phone bills, for example).
• Overhead allocations. The next item to calculate is the overhead allocation for each associate. A method that may work best for law firms is “overhead per timekeeper.” A timekeeper is usually defined as someone whose primary purpose is to work on client matters (partners, associates, 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 timekeepers using the full-time equivalent (FTE) allocation system. Many firms do this by assigning an FTE of 1.0 to associates, a 1.5 to partners and a 0.5 to paralegals. The theory is that partners generally consume a greater share of the firm resources (bigger offices, more use of staff) than associates who, in turn, use more resources than paralegals. Firms can fit the FTE equation to their own circumstances. 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.

Example: ABC firm has four partners, 10 associates and four paralegals. This gives them FTEs of 18, or (4 x 1.5) + (10 x 1.0) + (4 x 0.5) = 18. If the firm’s overhead expenses total $750,000, the allocation to an associate would be $41,667 [($750,000/18) x 1].

Using the ABC firm in the above example, we can construct a personal P&L for Joe Associate with just a little more information. Joe billed 1,800 hours in 2004 at a billing rate of $150 per hour. Fifteen percent of his billable time was written off. His salary was $110,000 with a 10% bonus, and benefits and payroll taxes equal 20% of his salary expense (before bonus). This includes all his direct expenses including dues to the ABA . As previously shown, ABC’s overhead expenses were $750,000 for the fiscal year. (See the example below “Joe Associate’s personal P&L” to see what his P&L would look like.)

A picture paints a thousand words

While not perfect, the personal P&L gives ABC firm and Joe a fairly accurate picture of how much he contributes toward the firm’s success. Without going through this type of exercise, associates (and even some partners) may focus solely on their billable hours and assume they are contributing far more to the firm’s bottom line than they actually are. It helps to have the whole picture.

Example: Joe Associate’s personal P&L

Gross revenue from billable time $270,000

Less write-offs (40,500)

Net revenue $229,500

Direct costs

Salary and bonus $121,000

Benefits, payroll taxes and other direct costs 22,000

Total direct expenses $143,000

Gross profit attributable to Joe Associate $ 86,500

Less overhead allocation (41,667)

Net profit attributable to Joe Associate $ 44,833

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

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