When I talk to law students or young attorneys about law office management, I often show them the following formula as a method of getting them to think about structuring their practice:
Income = hourly rate x hours billed per week x weeks worked per year x percentage of billing collected x (1-percentage of overhead)
To put this formula in simple English, an attorney’s personal gross income (what he or she makes after paying business expenses but before paying personal taxes) is the hourly rate that attorney charges, multiplied by the number of hours that attorney bills per week, multiplied by the number of weeks that attorney works per year, multiplied by the percentage of billing time that the attorney is able to collect, multiplied by one minus the percentage of the attorney’s collected fees that go towards overhead.
For attorneys who have not thought about it, many would assume that the two most important figures in this formula are the hourly rate charged and the number of hours billed. These figures are important but they are not nearly as important as the percentage of billed time which results in collected fees and the percentage of collected fees that go towards overhead. For some attorneys’ law practice models these two items interact so that under 20% of an attorney’s billed time translates into money in that attorney’s pocket. For other attorneys, these two items interact so that over 75% of the attorney’s billed time results in personal income. The former attorney may work much harder than the latter attorney but still make half the income of the latter attorney.
To illustrate: Attorneys A and B both bill at $200 per hour. Attorney A takes in every case he can and needs substantial staff (and overhead) to service his clients–70% of the fees he collects go to overhead. He bills forty hours a week (eight hours a day) and rarely takes time off–working 50 weeks a year. However, because he isn’t selective in the cases he takes he only collects 60% of what he bills.
Attorney B is more selective about the cases she takes and thus does not have as much work. She only bills twenty-five hours a week (five hours a day) and takes six weeks off a year (working 46 weeks a year). Because she is selective in the case she takes, she collects 90% of what she bills and keeps her overhead to 20% of what she collects.
So what do Attorneys A and B earn after paying expenses? Attorney A makes $200 x 40 x 50 x 0.6 x (1 – 0.7) or $72,000. Attorney B makes $200 x 25 x 46 x 0.9 x (1 – 0.2) or $165,600. In this scenario Attorney A could double his hourly rate but, even assuming the number of hours he could bill and the percentage of his billed time he collected for remained the same, if he doubled his overhead as a result he would still make less money than Attorney B.
My observation of solo attorneys’ law practice management is that higher hourly rates typically lead to a lower collection rate. More hours billed lead both to lower collection rates and higher percentage of overhead. Each attorney needs to balance these factors in a manner that works for his or her practice. However, being cognizant of making sure one is likely to be able to collect for the time one bills, and making sure that one’s overhead is necessary to productivity, is likely to result in a more satisfying practice and greater income. Working long hours on numerous cases for which one will not ultimately receive pay is not nearly as enjoyable as working shorter hours on fewer cases knowing that one will be paid for helping one’s clients.
Attorneys, especially young attorneys, are often loathe to take time away from work. However a 2% increase in collection rate, or a decrease of 2% in the amount of fees going to overhead, enables an attorney to take an additional week of vacation without any loss of income.
By avoiding unnecessary overhead while being careful about taking on clients who are unlikely to pay their bill, one can increase one’s income while having a more rewarding law practice.
Thank you for posting this. Taking fewer cases and making more money seems counterintuitive, but it really does make sense. A hard lesson for me to learn my first year in solo practice!
Greg, great article. One thing you might mention is the need for retainers. Makes life easier as well.
Keep up the good work.
Joe