Sole Practitioners Must Know Their Cost Per Hour
I have known more than a few attorneys who were abysmal at math. Fortunately, a brilliant secretary or handy calculator was around to bail them out on almost every occasion. Of course, these individuals did not become lawyers to do math problems and as long as they could compute (knew) their target cost per hour to make their desired profits, all was well and their practices succeeded, if not, thrived.
When starting a law practice, a firm commitment to marketing the firm for so many hours a week is essential to success. Estimates of costs and hours may be used when making this computation.
How does an attorney determine his or her cost per hour?
Below is an example for a sole practitioner.
A simple method of computing this cost is fixed operating costs per budgeted income statement:
*Fixed Operating Costs (rent, utilities, office equipment, and supplies, services, etc.) $100,000
*Lawyer’s required draw, which includes compensation, fringe benefits, taxes, and contributions to a retirement plan: $80,000
*Total cost to recover $180,000
Billable hours = 2,080 (Total hours available for work 52 weeks per year @ 40 hours per week)
Office administration – 1 hour per day -260
Marketing time – 2 hours per week -104
Professional activities – 2 hours per month -24
Pro Bono commitment – 4 hours per month -48
Mandatory CLE attendance -15
Vacation – 2 weeks per year -80
Holidays – 8 days per year -64
Sick days – 5 days per year -40
Net billable hours 1,445
Cost per hour = Cost to recover / Net billable hours $124.57
All the numbers in this computation are variable (except for 52 weeks in the year). It is crucial not to underestimate any of these factors. For example, if you decide to commit 80 hours per week to your practice and eliminate vacation and holiday hours, your draw may substantially increase, but your spouse and children will probably leave and you will have to support two households instead of only one.
Remember that not every hour billed may be collected and at least 10% should be factored into the cost-per-hour analysis as an additional “cost.”
(1,445 hours -144 = 1,301; $180,000/1,301 = $138.36 cost per hour)
$138.36 cost per hour
Lawyers should periodically review their business plan to remind themselves of their goals in practicing law. For example, Lawyers who have made a personal commitment to providing pro bono services should ensure that they are regularly committing enough hours to this work.
If an attorney’s fee structure is entirely based on billings per hour, the cost per hour may be a consideration in setting billing rates. Using the above example of a cost of $138 per hour, a billing rate of only $110 per hour will require serious adjustments to bring the cost down to $115. If a billing rate is $200 per hour and the cost is only $138 per hour, any problem is solved.
Profit is an attorney’s income and what he or she receives after paying the overhead costs of the practice. Industry data suggest that attorneys may expect to keep about 55% to 70% of every dollar of fees. This percentage includes disposal income, fringe benefits, and retirement plan contributions.
For a practice that operates solely on fixed fees, the cost per hour may be used in setting the fixed fee. Fixed fee work assumes an “average” number of hours needed to produce the results requested by the client. Summarize the time spent on different kinds of cases, i.e. criminal defense, divorce, bankruptcy, etc., and calculate the average hours per matter. This average is multiplied by the cost per hour to determine the preliminary fixed fee. A fixed fee is likely a factor in the “market rate.” For example, if a Chapter 7 bankruptcy filing may be prepared for filing in 10 hours and the cost per hour is $100 per hour, the fixed fee at $1,000.
For personal injury practices with contingent fees, a record of hours expended on each matter should be kept. The cost relative to the estimate of the expected fee should be monitored. If the hours required to handle a matter that generates a $4,000 fee are the same as the hours required for a case that generates an $8,000 fee, perhaps more selectivity in choosing cases may be necessary.
Most lawyers use a combination of billing methods and should review hourly cost versus actual fee income to help them determine where to target and concentrate efforts for new business or even to revise their fee arrangements.
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