\n

Overhead Ratios of a Law Firm

22610 Views
The typical law office spends 45 to 50 percent of the fee dollar on the expenses of operating the office. These funds go for non-lawyer salaries, rent, telephone, library, equipment, supplies and other facilities. The comparison of overhead percentage ratios is, in fact, quite a game among some lawyers. We are often asked: "What should a law firm's overhead ratio be?" An answer such as 45 percent, derived from some recent survey, will often satisfy the questioner; or he may be unhappy because he realizes that in his shop, the figure is higher, say 55 percent.

Actually, the percentage ratio of overhead is quite unimportant and firm to firm comparisons of this number may be misleading. One Western firm of three lawyers that provided information to the authors for 1987 showed an expense ratio of 60 percent. Non-lawyer salaries alone were taking 30 percent of every fee dollar. Some firms of that size can operate on a 38 percent total expense ratio!



But the lawyers of that firm averaged income of $175,000 each in 1987, a figure far above normal. The firm used paralegal assistants and modern techniques to improve the productivity of its lawyers rather than hiring more lawyers. Such innovations change overhead ratios from the "norms" quoted in some quarters, but the dollar rewards of such organization speak for themselves.

In calculating the percentage of gross receipts spent on overhead, the compensation of all lawyers is normally excluded. That is, all payments to lawyers are treated as part of "profit." Unless this is done, a firm will be unable to compare its own year-to-year overhead ratio. Here's why:

Green and Jones operated as a partnership of two partners with an associate. The firm's annual financial report showed:
  • Gross Receipts $140,000 = 100.0%
  • Expenses (except Associate ) 40,000 = 28.6%
  • Associate's Cost 20,000 = 14.3%
  • Profit 80,000 = 57.2%
Then the associate becomes a partner, but the next year duplicates the financial results:
  • Gross Receipts $140,000 = 100.0%
  • Expenses 40,000 = 28.6%
  • Profit Then 100,000 = 71.4%
Actually, what we have termed "profit" here is really "lawyer compensation." If Green and Jones now become a professional corporation, and still want to compare their year-to-year financial results, they will have to adopt the latter term.

The overall percentage or proportion of gross fees a firm expends on all cost items is not important. For the firm with an entertainment clientele which needs posh offices, it helps little to know that the average law office expends about eight percent of its gross on occupancy. A firm which has developed the paralegal concept to the point where it employs an average of four non-lawyers to each lawyer will not meet the "norm" of spending eighteen percent of gross on non-lawyer employment costs. The fact that most firms spends one percent of fees on library will not impress the senior partner with a love for books, nor the isolated small town firm which must maintain a substantial library.

Actually, the ratio of expenses to gross fees will change dramatically if billing is increased while the line is held on expenses. Quite often, the law firm which seeks consulting advice because of a high overhead ratio needs help not in controlling its costs, but in its methods of billing and collection. On the other hand, many very prosperous law firms operate with a very high percentage of overhead costs. It often takes money to make money.

Capital Accounts

In a partnership, paid-in capital consists of funds belonging to individual partners which have been turned over to the firm. Generally speaking, these accounts divide into two distinctively different parts:
  1. Invested capital is the un-depreciated value of furniture, library, office machines, leasehold improvements, buildings and the like. These items are the firm's fixed assets.
     
  2. Cash reserves are funds which belong to the partners, but are held, either temporarily or permanently, to meet the cash needs of the firm.
When a law firm purchases an item that cannot be expensed in the year of purchase, the result is an addition to the partners' capital accounts. For example, most office machines will be depreciated over a period of five years. If straight depreciation is used, this means that 20 percent of the value of the machine will be reported as an expense each year. In the first year, the other 80 percent comes out of the after-tax pockets of the partners.

There are various methods of crediting the amounts to partners' individual accounts. Most often, each partner is charged with such expenditures in the proportion of his or her interest in the profits of the firm. In other words, a partner who will receive 30 percent of firm profit will also make a 30 percent contribution to nondeductible expenses. By the same token, the partner will receive 30 percent of the depreciation credit for purchases of former years. A firm may, however, allocate capital contributions in a different way from profit distribution. This requires a specific agreement.

Most firms pay their partners on a regular weekly or monthly schedule. But some pay partners only when a drawing is requested by one of them. This may mean that some partners leave their shares of money in the firm, while others may withdraw their share, or more. When this happens, cash capital accounts must be constantly altered.

Some partnerships make a distinction between required cash capital or reserves and temporarily-held profit.
This whole picture is, of course, different for those law firms which operate in the corporate form. Corporations have paid-in capital, but they issue stock in exchange.

In a corporation, capital is usually contributed in the ratio of shares owned, but not necessarily in any correlation with compensation received. Only profits must be distributed on the basis of shares in the form of dividends, but in law firm corporations most of the owners' compensation will result from being employees rather than shareholders.

Cash Flow and Control

Little attention is paid by many law firms to matters of cash flow and short term investment of firm funds.
Some law firms insist on a substantial reserve of cash. Few firms need more cash on hand than the expenses of one month of operation, and some can get by on less. (Exceptions are firms which deal in few, large matters which cause very irregular cash flow). A line of credit with a bank may be as good as a substantial cash reserve.

Professional corporations may require short loans at the end of the year to guard against reporting substantial profits. Otherwise, a professional corporation which has purchased any amount of capitalized items, not deductible in the year of purchase, will show a book profit, even though the funds are expended. The Federal and state governments will then levy a tax on the profits. A loan enables the corporation to run out enough bonuses to employee-owners to minimize profit.

Quite often, law firms accumulate substantial sums of money during the year, and some allow such funds to sit idle. This only means that the bank, rather than the lawyers who own the funds, will collect interest on the deposits. Accumulations should be invested, either in interest-bearing accounts or certificates of deposit, or in higher yielding short term commercial paper. A good broker can be an invaluable help in managing such funds.

Near the end of the tax year, billing should consider the time-of-payment factor. Depending on how the year has gone, a firm's management may want to accelerate or slow up collections. This factor should receive constant attention during the last quarter of any year.

Budgeting Expense

The development of a budget for expenditure of funds is important both as a goal setting device and also as a means of delegating authority for expenditures without the need for a managing group to become involved in each specific purchase. In some law firms too much time is wasted in discussions of the merits of specific items of equipment or the need for an additional adding machine. A budget, which is adopted once a year by the governing body, can shortcut some of these discussions and enable a firm to plan its finances more carefully.

Budget for Expenses, while not complete in every detail, is a type of budgeting method which might be used by a more substantial law firm. Disbursements on behalf of clients are included as a reminder that this can be a source of considerable unprofitable investments for a law firm. This specimen partial budget states a summary of the firm's policy regarding disbursement.

The budget may delegate spending authority to various positions. In the illustration, the managing partner is assigned responsibility for purchase of hardware while the business manager has received authority to expend funds for salaries and supplies, etc. Another approach is to give an office manager a maximum spending authority, including the right to sign purchase contracts, up to a certain amount, i.e., $500; reserving to a managing partner or an executive committee the right of approval of any more substantial expenditure.

The firm that wants to hold one or two individuals responsible for determining the level of expenditures must, of course, give them the necessary authority to deny purchases even when requested by partners.

No budget can foresee all of the possible events which will occur within the budget period of one year. In our illustration for example, we have shown an item of $12,000 for printing and supplies. Turnover in the professional complement of a firm might quite easily cause an increase in that budget beyond $12,000. This would not be within the control of the business manager. Normal budgetary procedure is for the business manager to prepare a supplemental budget for the additional,
required funds and to have it approved by the prescribed authority within the firm.

The same principle applies to all goal-setting activity. It is not always possible to foresee the contingencies which will arise, and consequently, goals may need review and alteration during the goal period. The stated goals must always be realistic.

Recouping Cash Advances for Clients

Advances made in a client's behalf for filing fees, expert witnesses, or for specific items purchased for use in a legal matter, have traditionally been billed to clients as "costs advanced" or "disbursements made" in the client's behalf.

[1}-Items Which Can Be Billed to a Client

Decades ago it was necessary for most law firms to take papers outside of their office for copying, but today firms have their own copiers and provide the service to their clients. Some firms which had no hesitancy in passing along the cost for outside copying have hesitated to bill clients for the cost of in-house copying. A majority of firms do charge clients for this service at cost, often on a hit or miss basis. Where a long distance phone call is required to advance a client's matter, the toll charge is generally billed to the client. Where the client's convenience or the cause of his legal matter is served by the lawyer traveling out of his home town, the client is usually charged for mileage, plane fare, tolls and parking. The test appears to be "Does all of the legal work of this firm require this expense, the cost of which is included in the lawyer's hourly rate or does the need for this service vary from case to case?" In the latter case, it would be inequitable to charge all clients pro rata for it. Clearly the client whose work can be done in the lawyer's office should not share the expense created by another client who requires that the lawyer travel a hundred miles on his case. This extraordinary expense is not part of the general cost of doing business which is factored into the lawyer's fee structure.

This philosophy can be applied to other instances of costs advanced for the benefit of the client and his cause: providing notarial service, using registered or certified mail rather than ordinary mail, requiring secretarial overtime because of the client's case (not the procrastination of the lawyer), special duplication, photographs, and the like.

Some firms even charge secretarial time to clients independently of the lawyer's time, on the theory that some matters take little professional time and a great deal of clerical time, whereas other work requires lawyer time heavily and little clerical work. In this case, of course, the full cost of clerical salaries and benefits should not be used in determining the lawyer's hourly rate. A rate will have to be established for clerical chargeable time. This type of clerical and lawyer hourly rate structure is becoming increasingly necessary because of the growing number of paralegal employees. If a paralegal has a billable rate, the whole overhead for that paralegal should not be included in computing a lawyer's billable rates, any more than the cost of employing an associate would be included in computing a partner's hourly rate.

[2]-Accounting for Miscellaneous Items

The most troublesome cost-advanced items, in terms of record keeping, are the small costs, such as petty cash, telephone charges, postage and photocopy charges. The collection and posting of these charges can be accomplished in a number of ways. Some systems, however, are grossly inefficient and generally result in losses.

Many offices have used lists for such charges. A sheet may be placed beside the photocopy machine and staff is instructed to write the client's name and the charge on the sheet, as copies are made.

Monthly, or more often, the bookkeeper must distribute these charges on a spread sheet in order to arrive at the amount to be charged to each matter or client. This is an inefficient and time-consuming process and is subject to error.

A better alternative is to complete a voucher slip for each charge. This is cheaper for the simple reason that the voucher slip can be sorted, while a list must be copied. It is more efficient to sort than to copy and recopy.

It is possible to have the telephone long distance operator call back with time and charges if the call is placed through an operator, but this costs additional money and clerical time. Direct dialing is the most reasonable and the most used method for long distance telephone work, but is the most difficult to control.

As the voucher slips are completed they should go to a central location, such as bookkeeping, where they will be held in date sequence until the telephone bill is received. At that time, by using reference to the date and number, the charge can be entered on each slip and the tax added. The slips would then be totaled and one entry made to the client's ledger for all of the calls to be charged. The slips may be retained until the bill is paid or a few months thereafter. Since the telephone company bill is the primary record of the expense, there is no need to retain the voucher slips for a long time.

A similar procedure can be used for the voucher slips completed for photocopying, postage and petty cash, with the one ledger entry for each or a combined total entry placed in the client's ledger.

Any law firm can realize the recoupment of many dollars of expense through better control over costs advanced for clients. If they are not recouped from the client they will come from the lawyer's pocket. One New York law firm of twenty lawyers reported an increase of $15,000 in costs reimbursed to the firm in a six-month period after a tight control was begun over miscellaneous costs advanced.

Handling Trust Accounts

The trust account is called by a variety of names in different areas. In some locations it is called the "client account," in others, the "escrow account" or the "attorneys' account." What it is called, however, is not nearly so important as the way in which this bank account is controlled and supervised.

Following is a series of guidelines handed down a few years ago by the Arizona Supreme Court, which details the proper handling of a trust account in a law firm.

The following guidelines have been adopted by the Board of Governors of the State Bar of Arizona, pursuant to Rule 29(f) (5), Rules of the Supreme Court, in order to set minimum standards to ensure that each member is in compliance with the provisions of Disciplinary Rule 9-102, Code of Professional Responsibility, and Rule 29(f), Rules of the Supreme Court, relating to trust accounts.

1. Disciplinary Rule 9-102, Code of Professional Responsibility provides in part as follows:

"DR 9-102. Preserving Identity of Funds and Property of a Client.
 
  • All funds of clients paid to a lawyer or law firm, other than advances for costs and expenses, shall be deposited in one or more identifiable bank accounts maintained in the state in which the law office is situated and no funds belonging to the lawyer or law firm shall be deposited therein except as follows:
  1. Funds reasonably sufficient to pay bank charges may be de-posited therein.
  2. Funds belonging in part to a client and in part presently or potentially to the lawyer or law firm must be deposited therein but the portion belonging to the lawyer or law firm may be withdrawn when due unless the right of the lawyer or law firm to receive it is disputed by the client, in which event the disputed portion shall not be withdrawn until the dispute is finally resolved.
  • A lawyer shall:
  1. Promptly notify a client of the receipt of his funds, securities, or other properties.
     
  2. Identify and label securities and properties of a client promptly upon receipt and place them in a safe deposit box or other place of safekeeping as soon as practicable.
     
  3. Maintain complete records of all funds, securities, and other properties of a client coming into the possession of the lawyer and render appropriate accounts to his clients regarding them.
     
  4. Promptly pay or deliver to the client as requested by a client the funds, securities, or other properties of the lawyer which the client is entitled to receive."
2. Rule 29(f), Rules of the Supreme Court, provides in part as follows:

29 (f) Trust Account Verification Rule
  1. Every active member of the bar shall maintain complete re-cords of the handling, maintenance and disposition of all funds, securities and other assets of a client which have at any time come into his possession. These records shall cover the entire time from the receipt to the time of final disposition by the attorney of all such funds, securities, and other assets. Said funds shall be maintained in a trust account, labeled as such, and kept separate and apart from the attorney's personal and business accounts. Said attorney shall preserve these records for a period of five years after final disposition by him of said funds, securities, and other assets.
     
  2. This Court may order the audit of a member's trust account based on information received by the board of governors that Canon One and/or Nine of the Code of Professional Responsibility may have been violated. No such audit shall be con-ducted until approval has been granted by a Justice of Arizona Supreme Court after a petition is presented by the board. Good cause shall be shown before approval to conduct such audit is granted.
(5) The maintenance of trust accounts by members of the bar and the audit of lawyer's trust accounts as provided by this rule, shall be in accordance with minimum guidelines established by the board of governors.

Standards of Performance
  • Due professional care must be exercised in all aspects of the performance of the attorney's fiduciary duties, including, but not limited to, maintaining records and selecting banks, accountants and others who perform necessary services.
     
  • Assistants employees and others helping to perform the attorney's fiduciary duties must be competent and are to be properly supervised.
     
  • Internal controls within the attorney's office must be adequate to safeguard the client's assets, to check accuracy and reliability of all data and to comply with applicable laws and regulations.
     
  • Careful and complete recordation of all transactions must be made promptly.
     
  • Periodic and timely reports must be rendered to the client which fairly present the transactions and their results on a consistent basis. The reports should contain comprehensive disclosures which are adequate to the needs of the client.
Minimum Requirements for Books and Records Maintenance

As a minimum requirement, every attorney engaged in the private practice of law in the State of Arizona shall maintain on a current basis, books and records which establish his compliance with DR 9-102 and Rule 29(f)(1), and which shall be preserved for at least five years following the completion of his fiduciary obligation. For this purpose the following books and records are required for all fiduciary funds and property (including all funds held for clients or others):
  • A cash receipts journal listing the sources of the receipt and the date of the receipt. Receipts should be deposited intact and the duplicate deposit slip should be sufficiently detailed to identify each item.
     
  • A disbursements journal listing the date of the disbursement and payee. All disbursements are to be made by check.
     
  • A subsidiary ledger containing a separate page for each person or company for whom monies have been received in trust, showing the date of receipt and the amount, the date of the disbursement and the amount, and any unexpended balance.
     
  • A monthly reconciliation at month-end of the cash balance derived from the cash receipts and cash disbursements journal totals, the checkbook balance, the bank statement balance and the subsidiary ledger trial balance total.
     
  • Bank statements, cancelled, pre-numbered checks and duplicate deposit slips.
     
  • A record showing all property, specifically identified other than cash, held in trust from time to time for clients or others, including date received, and where located. The property of a client must be placed in a safe deposit box or other place of safekeeping as soon as practicable.
     
  • Copies of appropriate documents providing evidence of disbursements of funds and accountings to clients and others of trust account funds. No more than one year should elapse before such accountings are made.
Disposition of Retainer Fees Until Earned

Any funds received as fees by the attorney from the client shall be deposited in the attorney's trust account until earned, unless there is a written agreement with the client that such fees are earned at the time paid.

The foregoing points out some of the main Trust Account errors committed by law firms of all sizes:
  1. Law firms should not deposit and retain fee receipts in the trust account. Where a receipt represents partly clients' money and partly earned fees, the fee amount should be withdrawn and transferred into the firm general operating account. Some firms use the trust account as a clearing account for all receipts. Not only does this process cause unnecessary bookkeeping entries, but also it increases the volume of transactions handled by the trust account and increases the possibility of error.
     
  2. Trust account records should not be available to other than trained and trusted bookkeeping personnel. In some firms, all secretaries have access to trust checkbooks. This practice should be strictly avoided.
     
  3. A monthly reconciliation of the trust account books is important. Some firms never balance the trust account. In Arizona, failure to record monthly checks on the account could give rise to disciplinary action. In any jurisdiction improper accounting procedures can cause embarrassment or worse.

Please see the following articles for more information about law firm jobs:
   
 
Please see the following articles for more information about law firm jobs:
 




Featured Testimonials

LawCrossing UK is a very user friendly site. I found my job pretty quickly.
David


Facts

LawCrossing Fact #79: Users who add jobs to their “hotlists” will be more likely to find jobs in the future than those who don’t because they will have already searched when it comes time to change jobs.


Location
Chicago, IL
Description
Litigation Staff Attorney The candidate should be licensed to practice law in the state of Illinois...
Location
Miami, FL
Description
Customer Services and Sales Representative Responsibilities: The candidate shall apply sales techni...
Apply now  
Location
Atlanta, GA
Description
Personal Injury Paralegal The candidate will work client files through the various stages of pre-li...
Apply now  
Location
New York City, NY
Description
Senior Billing Assistant Temp Duties: Acts as a back up in monitoring the billing mail-box. Assists...
Apply now  
Location
Phoenix, AZ
Description
Associate Attorney The candidate will join civil litigation law firm and must have passed Arizona b...
Location
Beverly Hills, CA
Description

Job start date is January 2, 2017.

Looking for Bilingual (Spanish/English

Apply now  
 

NOW TRENDING ON BCG ATTORNEY SEARCH

MOST POPULAR ARTICLES

Testimonial of the Week

LawCrossing has the most listings of any job board I have used. It's actually a great site. The website had a lot of detail. It’s nice that you don't have to go through a recruiter if you don't want to. You can actually contact the law firm directly for the positions listed. LawCrossing had a ton of great features.
  • Brian McMillan San Francisco, CA
Job of the Day

Boston Products Liability Litigation Attorneys

Boston, MA

Bliss Lawyers is seeking products liability litigation attorneys with at least five years of experience to work in the B...

Employer: Bliss Lawyers

Job Search Tip

White space on a resume is important. Leave big margins on all sides and lots of white space in the middle. The average recruiter reads hundreds of resumes a month. Make yours easy to read.

Testimonial of the week

I was able to obtain my new job through LawCrossing. I love your service! Hopefully, I won't need your help for a while, but if I do, I'll certainly sign up again. I have already told others about your great site.
  • Theresa D. Colorado
+Read More Testimonial
  • All we do is research jobs
  • Our team of researchers, programmers, and analysts find you jobs from over 50,000 career pages and other sources
  • Our members get more interviews and jobs than people who use "public job boards"