The Billable Hour Is Not Dead!

Firms are increasingly using alternative fee structures to meet clients' demands for billing based on the perceived value they have received. This article discusses the reasons why, regardless of your firm's method of billing clients, it is still critical to track attorney billable and non-billable hours.

Client Demand for Value Pricing

Firms are changing the way they price work as clients look for more value-based billing. Small and medium-sized firms are winning new clients by moving away from a simple “hours multiplied by our standard billing rate” price for legal services. Clients are demanding that legal services be priced according to perceived value, such as successful completion of a particular assignment, and that law firms share in the business risk of the transaction. Under value-based billing arrangements, attorneys price client work using a fixed fee or attach the price of their legal services to a successful outcome, such as the completion of a round of financing or successful pursuit of a legal action.

For those firms that are tempted to discard time sheets entirely, understand that tracking hours for billing purposes is only one part of an integrated system of cost accounting encompassing pricing, realization, attorney utilization and accountability. Tracking hours gives you critical data that cannot be replaced; billable hours are one of the key performance metrics that successful firms use to drive superior profitability.

Separation of Hours and Price

Many attorneys connect the tracking of hours with the determination of the price for legal services. However, hours are only one factor an attorney considers in determining price. Billing attorneys make final pricing decisions at the billing stage, writing standard hours up or down before a final bill is created. Maybe the client will not pay for paralegal time. Maybe the client caps the accepted hourly rates for associates. This pricing decision at the billing stage reflects another important metric, Realization (the actual amount billed divided by the value of work at standard hourly rates). Alternative fee structures are just making this billing process more complicated and the calculation of realization even more important.

Some commentators argue that the value that an attorney brings to a client matter cannot be measured in a simple hours times billing rate equation; it is a combination of the attorney's knowledge, experience and skill, as well as obtaining a good result for the client. This argument still connects the hours with pricing. A pricing decision can be made at the billing stage; a billing attorney can override the “hours times rate” and determine a fee based on a value-billing scenario.

Profitability of Work

Billable hours and the cost of billable hours are key factors in determining profitability of work. If an attorney spends his time in any one month on more than one matter or more than one client, the only way the law firm can allocate the cost of labor between matters and clients is by tracking the hours it takes that attorney to complete each assignment.

Firms set standard hourly rates to ensure that for each hour an attorney works, the firm earns enough of a fee to cover the cost of the employee, benefits, overhead and a sufficient profit for the firm and its partners. To monitor this, the firm should calculate the attorney's production for the year (billable hours ' standard rate) and divide this by the attorney's salary. A ratio of at least three is a common benchmark that many firms set as a goal.

To use an example from a different type of business: When a manufacturer is making a widget, his cost accounting system calculates whether he is making the widget profitably. He factors in the cost of materials, labor and a share of overheads and determines the standard cost per widget. Then he makes sure he sells each widget at a high enough margin to generate the required amount of profit. If the market will not accept the price, he uses his cost accounting data to drive down the cost per widget.

Without tracking billable hours, it is difficult for a firm to determine the profitability of client work it does. How can the firm determine that a fixed fee is sufficient to cover the costs of an assignment and generate enough profit for the firm if it does not measure the hours spent completing the assignment? Ultimately, the firm needs cost data to determine whether a client is profitable for the firm, and whether a practice area is going to be sufficiently profitable to be worth expending resources to grow. Attorneys pursuing new clients need to be able to price work appropriately, even in a fixed-fee or value-billing environment. Billable hours are the key.

By analyzing hours data, firms can determine the profitability of particular practice areas. A firm cannot continue to operate practice areas that are not profitable because they erode the profits of other successful practice areas. A firm that operates one practice area at a loss may not adequately reward the attorneys working in the other profitable practice areas because the firm's profits overall are eroded.

Accountability and Evaluations

Throw away time sheets and the majority of attorneys will work just as hard. However, most attorneys need targets and accountability to remain focused and productive. Without setting billable hours goals and tracking hours there is a risk that these attorneys will not work hard enough to meet profitability targets.

Billable hours worked is one quantitative criterion to use to evaluate associates. The larger the firm gets and the greater the number of associates a firm employs, the more difficult it is for the firm to have objective criteria for comparison purposes, without tracking billable hours.

It has been argued that firms that do not use time sheets use other criteria to evaluate associates and partners. They can certainly look at qualitative criteria such as the value delivered to a client, achieving a successful result in a case, and other non-client criteria such as business development activities. However, it is not always easy to measure these things at all levels of the firm; for example, it is easier to measure value delivered at the partner level than it is at the associate level. The qualitative criteria can be more subjective, and different partners may see associates in different ways. Partners are always going to have their favorites, particularly those who work for them, and may not be objective in evaluating these associates. Therefore, the leadership of the firm needs to have objective criteria to use to evaluate everyone. Billable hours are one objective criterion they can use.

When evaluating partners, billable hours are also a key metric used for determining compensation. The firm should measure partner billable hours against targets and against other partners. This is important for partners who do not have a large book of business, since the firm cannot compare fee billings. However, it is also important for comparing partners with large practices by looking at their managed charge hours. Comparing managed charged hours enables the firm to evaluate which partners leverage their time by keeping multiple associates and other partners busy.

Capacity and the Scheduling Process

Capacity in a law firm is determined by the maximum available billable hours. Effective scheduling is one of the key success factors for a law firm to be profitable. In his book “Managing the Professional Service Firm,” David Maister called it “the single most important managerial activity in a professional service firm.” The firm needs to have a projection of the amount of work that each attorney has over the next month, three months, six months and year in order to know the amount of backlog that the firm has. Who has too much work and who does not have enough?

The firm's senior management should meet weekly to review the schedule, determining who needs work, who is too busy, and then move work around appropriately. Scheduling can be a key driver for success because it proactively addresses utilization ' a critical profitability metric in a firm. Improving attorney utilization (which is measured by dividing billable hours by total hours) can drive profitability because the cost base is already in place. The value of every additional hour an attorney bills may drop to the bottom line (as long as the hour is good productive time), and without tracking billable hours the firm loses the opportunity to turn that additional hour into revenue.

The scheduling process helps the firm identify which practice areas need to step up business development efforts so they can bring in more work to keep their people busy. It is also part of the firm's budgeting and strategic planning process; firm management should look to the schedule to help determine whether the firm has excess resources or needs to hire more talent.

Allocation of Attorney Time

Tracking billable hours need not take away an attorney's focus from other important pursuits and uses of his time. Some commentators who argue that the billable hour is dead do so from the perspective of the attorney and the balance of how he splits his work time between working on client matters and other areas that build his skill-set such as continuing education, research and marketing. Workload and billable hour targets can be adjusted accordingly to enable attorneys to balance their time between client work and productive non-billable time.

A common problem attorneys with management responsibilities face is that the administrative tasks can expand to fill the day. Before you know it, too much time is spent on “important non-billable tasks.” The firm's client service and profitability may suffer as a result. By tracking billable hours, the firm can ensure that attorneys are managing their time appropriately between billable and non-billable tasks.

Conclusion

Regardless of your firm's method of billing clients, tracking billable and non-billable hours remains a key part of the cost accounting function and a critical success factor driving profitability and accountability in a law firm.

Neil F. Scullion, CPA is a director in the Law Firm Services Group at Feeley & Driscoll, P.C. (www.fdcpa.com). The Law Firm Services Group provides tax, accounting, business advisory and consulting services to law firms. Based in Boston, Scullion can be reached at [email protected] or by phone at 617-456-2475.

Firms are increasingly using alternative fee structures to meet clients' demands for billing based on the perceived value they have received. This article discusses the reasons why, regardless of your firm's method of billing clients, it is still critical to track attorney billable and non-billable hours.

Client Demand for Value Pricing

Firms are changing the way they price work as clients look for more value-based billing. Small and medium-sized firms are winning new clients by moving away from a simple “hours multiplied by our standard billing rate” price for legal services. Clients are demanding that legal services be priced according to perceived value, such as successful completion of a particular assignment, and that law firms share in the business risk of the transaction. Under value-based billing arrangements, attorneys price client work using a fixed fee or attach the price of their legal services to a successful outcome, such as the completion of a round of financing or successful pursuit of a legal action.

For those firms that are tempted to discard time sheets entirely, understand that tracking hours for billing purposes is only one part of an integrated system of cost accounting encompassing pricing, realization, attorney utilization and accountability. Tracking hours gives you critical data that cannot be replaced; billable hours are one of the key performance metrics that successful firms use to drive superior profitability.

Separation of Hours and Price

Many attorneys connect the tracking of hours with the determination of the price for legal services. However, hours are only one factor an attorney considers in determining price. Billing attorneys make final pricing decisions at the billing stage, writing standard hours up or down before a final bill is created. Maybe the client will not pay for paralegal time. Maybe the client caps the accepted hourly rates for associates. This pricing decision at the billing stage reflects another important metric, Realization (the actual amount billed divided by the value of work at standard hourly rates). Alternative fee structures are just making this billing process more complicated and the calculation of realization even more important.

Some commentators argue that the value that an attorney brings to a client matter cannot be measured in a simple hours times billing rate equation; it is a combination of the attorney's knowledge, experience and skill, as well as obtaining a good result for the client. This argument still connects the hours with pricing. A pricing decision can be made at the billing stage; a billing attorney can override the “hours times rate” and determine a fee based on a value-billing scenario.

Profitability of Work

Billable hours and the cost of billable hours are key factors in determining profitability of work. If an attorney spends his time in any one month on more than one matter or more than one client, the only way the law firm can allocate the cost of labor between matters and clients is by tracking the hours it takes that attorney to complete each assignment.

Firms set standard hourly rates to ensure that for each hour an attorney works, the firm earns enough of a fee to cover the cost of the employee, benefits, overhead and a sufficient profit for the firm and its partners. To monitor this, the firm should calculate the attorney's production for the year (billable hours ' standard rate) and divide this by the attorney's salary. A ratio of at least three is a common benchmark that many firms set as a goal.

To use an example from a different type of business: When a manufacturer is making a widget, his cost accounting system calculates whether he is making the widget profitably. He factors in the cost of materials, labor and a share of overheads and determines the standard cost per widget. Then he makes sure he sells each widget at a high enough margin to generate the required amount of profit. If the market will not accept the price, he uses his cost accounting data to drive down the cost per widget.

Without tracking billable hours, it is difficult for a firm to determine the profitability of client work it does. How can the firm determine that a fixed fee is sufficient to cover the costs of an assignment and generate enough profit for the firm if it does not measure the hours spent completing the assignment? Ultimately, the firm needs cost data to determine whether a client is profitable for the firm, and whether a practice area is going to be sufficiently profitable to be worth expending resources to grow. Attorneys pursuing new clients need to be able to price work appropriately, even in a fixed-fee or value-billing environment. Billable hours are the key.

By analyzing hours data, firms can determine the profitability of particular practice areas. A firm cannot continue to operate practice areas that are not profitable because they erode the profits of other successful practice areas. A firm that operates one practice area at a loss may not adequately reward the attorneys working in the other profitable practice areas because the firm's profits overall are eroded.

Accountability and Evaluations

Throw away time sheets and the majority of attorneys will work just as hard. However, most attorneys need targets and accountability to remain focused and productive. Without setting billable hours goals and tracking hours there is a risk that these attorneys will not work hard enough to meet profitability targets.

Billable hours worked is one quantitative criterion to use to evaluate associates. The larger the firm gets and the greater the number of associates a firm employs, the more difficult it is for the firm to have objective criteria for comparison purposes, without tracking billable hours.

It has been argued that firms that do not use time sheets use other criteria to evaluate associates and partners. They can certainly look at qualitative criteria such as the value delivered to a client, achieving a successful result in a case, and other non-client criteria such as business development activities. However, it is not always easy to measure these things at all levels of the firm; for example, it is easier to measure value delivered at the partner level than it is at the associate level. The qualitative criteria can be more subjective, and different partners may see associates in different ways. Partners are always going to have their favorites, particularly those who work for them, and may not be objective in evaluating these associates. Therefore, the leadership of the firm needs to have objective criteria to use to evaluate everyone. Billable hours are one objective criterion they can use.

When evaluating partners, billable hours are also a key metric used for determining compensation. The firm should measure partner billable hours against targets and against other partners. This is important for partners who do not have a large book of business, since the firm cannot compare fee billings. However, it is also important for comparing partners with large practices by looking at their managed charge hours. Comparing managed charged hours enables the firm to evaluate which partners leverage their time by keeping multiple associates and other partners busy.

Capacity and the Scheduling Process

Capacity in a law firm is determined by the maximum available billable hours. Effective scheduling is one of the key success factors for a law firm to be profitable. In his book “Managing the Professional Service Firm,” David Maister called it “the single most important managerial activity in a professional service firm.” The firm needs to have a projection of the amount of work that each attorney has over the next month, three months, six months and year in order to know the amount of backlog that the firm has. Who has too much work and who does not have enough?

The firm's senior management should meet weekly to review the schedule, determining who needs work, who is too busy, and then move work around appropriately. Scheduling can be a key driver for success because it proactively addresses utilization ' a critical profitability metric in a firm. Improving attorney utilization (which is measured by dividing billable hours by total hours) can drive profitability because the cost base is already in place. The value of every additional hour an attorney bills may drop to the bottom line (as long as the hour is good productive time), and without tracking billable hours the firm loses the opportunity to turn that additional hour into revenue.

The scheduling process helps the firm identify which practice areas need to step up business development efforts so they can bring in more work to keep their people busy. It is also part of the firm's budgeting and strategic planning process; firm management should look to the schedule to help determine whether the firm has excess resources or needs to hire more talent.

Allocation of Attorney Time

Tracking billable hours need not take away an attorney's focus from other important pursuits and uses of his time. Some commentators who argue that the billable hour is dead do so from the perspective of the attorney and the balance of how he splits his work time between working on client matters and other areas that build his skill-set such as continuing education, research and marketing. Workload and billable hour targets can be adjusted accordingly to enable attorneys to balance their time between client work and productive non-billable time.

A common problem attorneys with management responsibilities face is that the administrative tasks can expand to fill the day. Before you know it, too much time is spent on “important non-billable tasks.” The firm's client service and profitability may suffer as a result. By tracking billable hours, the firm can ensure that attorneys are managing their time appropriately between billable and non-billable tasks.

Conclusion

Regardless of your firm's method of billing clients, tracking billable and non-billable hours remains a key part of the cost accounting function and a critical success factor driving profitability and accountability in a law firm.

Neil F. Scullion, CPA is a director in the Law Firm Services Group at Feeley & Driscoll, P.C. (www.fdcpa.com). The Law Firm Services Group provides tax, accounting, business advisory and consulting services to law firms. Based in Boston, Scullion can be reached at [email protected] or by phone at 617-456-2475.