Profit = Revenues – Expenses. Profitability rate = Profit / Revenues.
This is the anatomy of profitability calculation.
But what is physiology?
Suppose we assume that physiology is the science of how the human body works. In that case, profitability physiology is a study of how profit generation works. To learn this physiology, you need to identify and manage various profit factors of law firm such as work, time, costs, and projects.
A useful timesheet for lawyers doesn’t only help you manage those factors, but it also helps to measure relations between them and improve profitability. This article will show you how to measure and manage these categories with a timesheet system. You’ll learn the physiology of profit creation!
Timesheet system for lawyers
Let’s go into more detail and see what features an attorney timesheet system brings.
Essential data in timesheets for law firms
A comprehensive timesheet system needs to contain data for profitability measurement from different aspects. Data processed in timesheets usually include:
- Total attorney’s work time
- Time spent on specific projects, tasks, and client
- Attorney’s billable time
- Attorney’s non-billable time
- Time utilization
- Attorney’s hourly rate
How to use time tracking software for lawyers
Using a tool like this may seem like a hassle, but it’s effortless to use. If the time tracking software is implemented in law firms, that should be used by all employees not only by lawyers. Here’s a detailed guide that will help you start.
Attorney (employee) point of view
Attorney time tracking should be both easy to use and suitable for data export relevant for productivity and profitability management. The lawyers (and other employees) usually fill following data:
- Date of work – that is usually set automatically. If an employee needs to book a vacation, they need to select a range of dates.
- Selecting check box indicating work related to the client or internal work
- Selecting a client drop list
- Choosing a project or service line from the drop list
- Selecting a working task from the drop list
- Input hourly rate
Management (partner’s) point of view
Data processed in timesheets should provide advanced reports and analytics on time consumption, tracking billable hours, and cost allocation from the managerial aspects. In other words, timesheet records altogether with managerial accounting figures are used for making business decisions relevant for achievement wished KPIs.
How to use a timesheet system to evaluate project profitability?
First of all, law firm timesheet records have to provide analytics of law firm performance management (KPIs). Such analytics contain data on:
- Hours (billable and non-billable)
Timesheet system usually doesn’t contain data on revenues, which could be easily exported from the accounting database. But analytics of lawyer’s hours and expenses is a must.
Let’s begin with revenues.
Revenues are the start point in profitability determination
A calculation of law firm revenues depends on agreement with clients. The revenues are usually charged based on:
- Attorney hourly rates
- Fixed fees
- Success or variable fees
Types of revenue
There are two main types of revenue. Here’s everything you need to know about them.
Revenue based on hourly rates
Billing on an legal hourly rate is the fairest — you bill what you worked for. Besides, profitability management is more effective because you can measure it.
On the other side, the question is, can hourly rates always be applied? Disadvantages of hourly rate based fees are:
- The client usually doesn’t prefer this as they lose control over their costs
- The client wants predictive fixed costs
- Even if a client accepts billing based on hourly rates, they rarely comply with invoices
A law firm should use timesheets and time tracking tools to provide (and increase) transparency of work performed.
Revenue based on fixed fees
The advantage of stable fixed legal fees is that you can make a reliable budget and planning activities. But for the calculation of project profitability, fixed rates can be deceptive for profitability assessment.
For the calculation and management of profitability, it’s necessary to calculate a law service fixed fee (as a product of the number of laywer working hours and hourly rate). After doing this, you’ll often find that the hourly rate is lower than the fixed rate and that you have a loss generating project.
As a result, we recommend that legal fixed fees should be intensely evaluated from the profitability point of view.
How to track law firm expenses in the timesheet system?
The law firm time tracking tool should allocate the expenses of each object. As mentioned, the objects could be projects, clients, service lines, or work tasks. The timesheet calculator tracks attorney’s work hours per object.
The expenses are calculated by multiplying allocated hours with the determined cost rate.
What kind of law firm expenses can be tracked
A law firm timesheet system can track two types of expenses — direct and indirect.
Direct labor expenses
Direct labor expenses include:
- Lawyer basic salary including taxes and social contributions
- Other benefits to lawyer
How to allocate direct costs to the specific project or client? Direct costs can be quite easily allocated to a particular project by multiplying the lawyer cost rate with total work hours spent on certain projects. To do this, you need to have a calculation of hours and costs based on accurate data.
Some other costs, such as recruitment, equipment, and mobile phone costs, fulfill the definition of direct costs. Still, their allocation can be more difficult and usually require a lot of manual work. You can classify these costs under indirect costs for easier allocation.
You can download an excel file for cost allocation and cost hourly rate suitable for application in timesheets.
Indirect expenses allocation
Indirect expenses aren’t directly related to a specific cost object (e.g., project or client). Those costs include sales, general, and administration costs that aren’t specifically related to the particular client.
How can you allocate indirect cost to the specific object? You need to allocate these costs to relevant objects starting with the determination of allocation keys. There’s no ideal allocation key. Thus you need to apply the most reasonable and independent keys.
For example, suppose you want to allocate rental and electricity costs to a specific project. In that case, you can use the total number of employees or work hours spent on a particular project. For example, if you have a project that consumes 30% of total employee work hours, you can allocate 30% of these costs to this project.
Timesheet system is a perfect tool for automatically allocating direct and indirect cost to projects, clients, or service lines.
“You can’t manage what you can’t measure.” – Peter Drucker
For effective cost management, a law firm time tracking software is an excellent tool for project cost management.
Law firm profit calculation with timesheet system
Timesheet management software can help you calculate profit easily.
Determination of profit
Profit is defined as a difference between revenues from legal services and expenses that result from business activities. Profitably measurement can be done via calculation of profitability rate related to profit achieved and revenues from sales.
Gross profit is the first level of law firm profitability. It’s calculated as the difference between sales and direct costs, such as the cost of goods sold. In service companies (e.g., law firms), gross profit is calculated as the difference between revenues from sales and labor cost (including bonuses and benefits).
Gross profit margin is an indicator of gross profitability, calculated by dividing gross profit with revenues from sales.
Operating profit is the second level of profitability. It’s calculated by deducting operating expenses from gross profit. Operating expenses usually include the following types of costs:
- Lawyer’s education
- General and administration
- Maintenance of equipment and software
- Insurance and health
Aggregate vs. specific profitability
To calculate the profit on an aggregate law firm level, you don’t need a timesheet system or cost tracking for each project.
But, did you ask yourself what does profit on the aggregate level hide? Let’s see the following graph:
Go into details and discover each client’s contribution to profit. You’ll see some low-performing and loss generating clines. Would this be the case in your law firm?
Profit per client based on timesheets tracking
Client profitability is the profit a law firm makes from serving an individual client or group of clients.
Calculating client profitability begins by identifying the wide range of expenses incurred concerning serving a specific customer. To determine such costs, first of all, you need to identify labor costs. Timesheet data provides essential information for the allocation of labor costs to a specific client.
Besides, based on reasonable allocation keys (e.g., based on attorney work hours spent), it is possible to allocate other costs.
Profit per project
Profit per project measures the profit achieved by a specific project.
The purpose of profit per project measurement is to evaluate the team’s ability to perform a project that generates profits.
You can look into a company’s profit-generating capacity by acquiring data from several profit-related indicators. This will provide you with insight into the company’s project performance and profit analysis. This data may highlight areas where improvements are required—for example, lawyer’s productivity, cost variance, and schedule adherence.
Suppose you set ambitious goals on project profitability as a manager. In that case, you need to keep striving to motivate your employees to push on with project quality as expressed by several parameters, such as:
● Adherence to schedule estimate
● Lawyer’s utilization rate
● Economic value added, and
● Return on capital employed
How much profit is earned by each lawyer?
When we say profit per lawyer, in this context, we don’t refer to KPIs such as net Income divided by the number of FTE. We refer to how much profit each lawyer makes considering total expenditures related to them. This is very hard to assess.
For example, if two lawyers spend 10 hours on a project, the total hours are 20. Project revenue is determined as a fixed fee amounting to 4,000 USD, so the average hourly rate is 200 USD. The cost of the first lawyer, based on his cost hourly rate calculation, is 1,000 USD. In comparison, the other lawyer’s cost is 1,500 USD, which implies that project profit is 1,500 USD.
By this calculation, the profit earned by the first lawyer is:
Revenue = 10 hours X 200 USD = 2,000 USD
Cost = 1,000 USD
Profit = 1,000 USD
The conclusion is that the first lawyer earns 1,000 USD, and another lawyer made 500 USD.
Is this calculation trustworthy and reliable?
We believe it’s not, because we can’t precisely know each lawyer’s real contribution to the profit generation. In other words, we didn’t include qualitative assumptions in this assessment. It’s possible that the second lawyer works more valuable tasks, and his contribution is higher.
But how to find out which lawyer creates profit and which not?
To make a reliable assessment, you need to view an overall picture and return to the client’s profitability. Identify which lawyers are mostly involved in low profit-generating clients and which lawyer is primarily involved in high profit-generating clients. This is why calculation of each client profitability is important.
What you can do to improve law firm profitability
Here are a couple of things you can do to ensure improving the profitability of your law business.
Have accurate timesheet calculations of hours and expenses
As mentioned, the only way to determine profit generated from a specific client is to make a cost allocation to them. But it’s impossible to make cost allocation without accurate attorney’s hours calculation.
That can be quite challenging because that may require significant manual work for hours calculation. Such manual work brings on more costs, so the final result of this approach is not guaranteed. Automated timesheet system is a better solution, but it also requires each employee’s time and effort.
Still, a simple law firm time tracking software with accurate and minimal required entries could be a reasonable solution.
Investigate which clients and projects have low profitability
Once you have revenues and expenses allocated to specific projects and clients, you can quickly identify profit margins. As presented above, overall profit could seem like an outstanding achievement. Still, if you go into detail, you’ll discover loss generating clients. Such engagement requires making some new decisions.
On the other side, you’ll identify a client that creates high profit. It can be a real surprise for you. Such engagement requires a new advanced approach as well.
Find out the reason for low profitability
After you make a list of your clients and projects by profitability from the timesheet system, you need to investigate the reason for low or high profitability in the next stage.
Costs point of view
- Who are lawyers involved in working with low-performing clients?
- Do they spend more hours than expected with specific clients?
- How can you improve their productivity? Can they be classified under low-performing lawyers?
- Who are lawyers involved in working with top-performing clients?
- Do your lawyers work too much on certain projects?
- Do you have too many lawyers involved in working with one client?
- Are the right people involved in working on the right projects?
- Do highly paid lawyers work on low sales-generating engagements?
- Should you switch low-performing clients to low-performing lawyers?
- How many hours are left unbillable?
- What is the structure of working tasks, and is there too much administration work done by senior lawyers?
Revenues point of view
- Have all hours been billable?
- Do you miss invoicing the performed work?
- If you take low-performing clients, list tasks performed and lawyers involved, what do they have in common?
- Do you have stable fixed project fees while hours spent on projects are increasing?
- Is it possible to re-negotiate fees in low performing engagements?
- What would be the impact on revenues if you terminate the contract with low-performing clients?
- Does the strategic relevance of some clients can be justification for the loss generated?
- What is your key managers’ work task structure, and what is their contribution to the revenue generation?
Discover Time Analytics as a simple law firm time tracking software
Time Analytics is a simple to use timesheet online tool that helps you answer the above questions and make the right decisions. Within this section, you can see how you can apply this timesheet system and improve project profitability.
How to calculate lawyer cost rate in timesheet software
The first step in Time Analytics set up is filling employee data. Besides necessary employee data, you’ll be asked to provide their cost rate.
Enter the work hour costs for each employee. Based on this information, the cost tracker details the costs of a specific project, multiplying the number of hours of all employees involved in the project by their cost hourly rate.
How to determine cost rate
You can either enter the:
- Direct cost rate, or
- Operating cost rate
If you want to focus more on gross profitability, you need to fill in a direct cost rate. That is calculated by dividing the total monthly salary by regular (expected) monthly hours spent to work. For example, if the gross monthly salary is 3,400 USD and the lawyer spends 170 hours each month, their cost rate would be 20 USD.
Suppose you prefer a more detailed calculation and want to focus on operating profitability management. In that case, you can enter the operating cost rate.
Operating cost rate = Direct cost rate + indirect cost rate
In addition to the salary, you need to include other general costs such as rentals, depreciation, maintenance ( further: operating costs). For example, suppose the monthly operating expenses amount to 1,700 USD per employee. In that case, you can calculate the indirect cost rate by dividing 1,700 by 170 hours. As a result, this cost rate is 10 USD while the total operating cost rate is 30 USD.
You can use historical or budgeted costs to calculate the hourly rate.
Timesheet filling by lawyers
The first criterion for the implementation of a timesheet solution is that it should be easy to use!
Time analysis provides:
- Simple interface for data entry (only a few minutes for daily entries)
- Use defined timesheet templates in a case of repetitive tasks
- Productivity driven self-dashboard for each employee (an employee may like Time Analytics because they can have insight into their productivity in the Analytics section)
Application of time records and cost hourly rates
After the lawyers fills daily tasks, projects, and hours, the timesheet system gathers all data and creates valuable reports. There are four dimensions of the reporting:
These reports present a list of all clients with total hours calculation for a certain period, tracking billable and non-billable hours, time utilization, and the cost of each client engagement. For each client, you can open a details section that shows the work structure for that client: who was involved, what tasks are done, which projects are done, and how many hours are spent per employee, task, and project.
2. Employee reports
Employee reports present a list of all employees with a structure of billable and non-billable hours, time utilization as a productivity indicator, and cost of each employee.
The projects report shows a list of projects with hours calculation, either billable and non-billable. You can also see the expenses related to each project, the people involved and performed tasks within a project.
4.Work tasks report
Working tasks reports show time consumption structure per different type of activities including the cost of each activity.
Evaluate cost per project and client
Evaluating cost per project or client is another thing a billable hour tracker can help you with.
Cost allocation per each client – calculate hours and costs
Cost allocation identifies, accumulates, and assigns costs to costs objects such as product departments, projects, clients, or service lines (CFI).
Timesheet system automatically allocates all generated costs to the object (in this case – clients). With this breakdown, you answer questions: what is the price of each client engagement?
In the Analytics section, you can see the cost breakdown for the selected period for each client. Besides, within a particular client, you can see all details: who performed the work, the services or tasks structure for the client, etc.
Calculate timesheet based costs per project
Same as cost per client, you can have detailed insight in cost per project with one click. Besides, you can have insight into how much each working task costs.
Discover where your profitability leaks
Now when you have an timesheet calculator, cost allocation, and foundation for specific profitability measurement, you can discover what profitability drivers are.
You simply compare revenues per client with cost per client from the timesheet system in the next stage. You’ll easily calculate gross or net margin per client or project.
After that, you’ll discover the reasons for low or high profitability for some clients. In terms of low profitability clients, you need to identify whether reasonable hours are spent for a particular client, who works on this engagement, and the real reason for low profitability.
Make smart decisions for improving the profitability
You need to answer the question:
Is the low profitability a consequence of the lawyer inefficiency or bad contractual terms with clients?
Check whether the same lawyers appear as engaged at low-profitability clients or projects. If so, you need to evaluate their work and productivity. On the bottom line, you can consider replacing them or giving them less complex tasks.
If you consider that engaged persons are highly productive, but you still have low profit at some clients, that is good news for you. This is what you can do:
- This information can be used to change contractual terms with clients
- Propose increase of your fees
- Consider termination of contract and make space for new clients
- Use this info for negotiation of new similar clients and engagements
Without attorney’s hours and cost tracking in timesheets, you won’t be able to take proper actions.
Focus on high profitable clients
Based on the work hours calculation described above, you’ll be able to set an advanced approach to high profitable clients:
- Focus on relationship improvement and invest in such clients
- Increase cross-selling and up-selling activities
Other profitability KPIs managed by law firm time tracking app
In addition to gross and net profitability per project, the timesheet system offers evaluation and management of other relevant KPIs. Those KPIs are:
- Total billable hours
- Time utilization
- Billable rate
- Average total hourly rate
- Cost rate
- Revenues per employee
- Net profit per employee
All these KPIs should be controlled at all times. Consequently, the time tracking software presents the main dashboard with the monthly movement of essential categories.
What industries can use timesheet automation for profitability improvement
Typically, timesheet systems are suitable for labor-intensive industries. Timesheets management software is usually applied in professional services:
- Law firms
- Accounting, audit, tax, and financial advisory firms
- Consulting firms
- Creative industry
- IT firms
- HR agencies and leadership and development firms
- Architectural firms
- Engineering consulting firms
- Health care firms
Looking at law firm aggregate profit can trick you.
You can’t achieve relevant profitability if you don’t have a system to follow each engagement’s revenues and costs. Only by accurate hours and costs tracking will you make a robust foundation for making smart decisions.
It is very important to chose the best time tracking app for law firms. Don’t forget that lawyers aren’t usually happy if they need to track their time because they can feel increased control. Thus, the timesheet system has to be easy to use. It needs to be more friendly and help lawyers improve their productivity.
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