Where the money goes: the matter as a small business

Lawyers are trained to think about a matter as a problem to solve. A firm has to think about it as a small business with an income and costs. Each matter takes in money, spends money on the people who do the work, and either leaves something over or does not. Most firms cannot say, for a given matter, whether it made money. This module gives you the six lines that answer the question.

1. Standard value. Every hour recorded, valued at the list rate of the person who worked it. It is what the time is worth on the rate card.
2. Billed. What actually went out on invoices, after any discount, write-down or fixed-fee agreement.
3. Collected. The cash that actually arrived.
4. Cost of the time. What those hours cost the firm to produce: the people, the office, the systems.
5. Unrecovered expenses. Costs of the matter that the client did not pay back.
6. Profit. Collected, less cost of time, less unrecovered expenses. Divide it by the cash collected and you have the margin.

• Realisation is the share of standard value that survives. Billing realisation is billed divided by standard value. The collection rate is collected divided by billed. Multiply them for overall realisation. Module 2 is about where the rest goes.
• Utilisation is billable hours divided by available hours. A lawyer who bills 1,350 of 1,800 available hours has a utilisation of 75%.
• Leverage is the number of non-partner fee earners for each partner. It is how a partner’s time is multiplied, and Module 6 returns to it.
• Margin is profit divided by revenue. Markup is profit divided by cost. A matter that costs $75,000 and collects $100,000 has a margin of 25% and a markup of 33%. Mixing the two up is the most common pricing error, and Module 5 shows what it costs.

An hour of a lawyer’s time costs more than their pay divided by the hours in a year. The firm also pays for the office they sit in, the systems they use, the people who support them, and the hours they do not bill, because no one bills every hour they are paid for. A fully loaded cost per hour divides all of that by the hours they actually bill. In this course an hour of every grade costs about two-thirds of its list rate. The exact share differs between firms and countries, but the point holds everywhere: an hour sold below its loaded cost loses money even when it earns a profit on the pay alone.

A firm’s average margin can look healthy while a few matters earn most of it and others lose money. Only a matter-by-matter view shows which kinds of work are priced well and which are not. It also shows the effect of the decisions made on a single matter: a discount agreed to win the work, a junior doing what a partner should have supervised, a bill that was never chased.

Even on a fixed-fee matter where the client never sees the hours, record them. They are the only way to learn afterwards whether the fee was right.

Cost allocation is a judgement: how much of the rent should one matter bear? Time records are imperfect, and some value (a client who refers three others, a case that builds a reputation) does not show up in a single matter’s profit. The figures in this course are invented and the rates are round. Treat the method as the lesson, and use your own firm’s numbers when you apply it.