Law Practice Management Asked and Answered Blog

Category: overhead

May 02, 2018

Law Firm Overhead and Profit Margins

Question: 

I am an attorney in New Orleans that has been a lawyer for ten years. I practiced with a small firm for eight years as an associate and then opened my own firm two years ago. I primarily work from home supplemented with a virtual pay-as-you-go office. I do not have any staff employees. I have been approached by a fourteen-attorney firm that would like me to join their firm as an income partner. Their offer includes a salary which I feel is low and a bonus based upon a percentage after covering my salary, other direct costs, and indirect firm overhead. The overhead allocations seem extremely high to me. In my practice I am bringing in around $100,000 in gross fees and my overhead averages $10,000-$15,000 per year. My profit margin is around 90%. I feel like I am better off building up my practice rather than accepting their offer. What are typical overhead and profit margins for law firms?

Response: 

We have to be careful how we define overhead. Overhead is generally to be considered all law firm expenses less attorney salaries and sometimes less paralegal salaries. The overhead ratio would then be the overhead divided by firm revenues. Profit margin is  expressed in terms of owner (partner, shareholder, etc.) earnings. In other words what is going into the owner’s pockets in terms of salary, share of profit, etc. Owner earnings is firm revenue less all firm expenses including associate and paralegal salaries but not including owner salary or compensation. The profit margin is total expenses (excluding owner compensation) divided by firm revenues.

A desirable profit margin range for law firms is thirty-five to forty-five percent.  Some firms are able to attain fifty percent. Profit margins depend upon the type of law practice, leverage ratios (associates to partners), how well the firm is managed, etc. I have some very successful firms with profit margins as low as twenty percent but the partner earnings are very high.

Your current overhead and profit margin is not sustainable in the long-term. While you have low overhead and a high profit margin you also have low earnings. You are only earning $85,000. You will soon reach a point where in order to increase your revenues you will have to hire people, acquire office space, and buy phone systems and other equipment. When this occurs you will be in a similar situation as to the law firm you are talking with.

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John W. Olmstead, MBA, Ph.D, CMC

May 06, 2014

Law Firm Overhead

Question:

I am the managing partner of an 8 attorney firm in Carbondale, Illinois. Recently I was talking with the managing partner of a firm in the area and we were discussing overhead ratios and we seemed to have different definitions of overhead and I am wondering if we were trying to compare apples to oranges. Can you share your thoughts?

Response:

I consider overhead to be the operating cost required to support the producers in the firm. This is a different statistic than expenses. Typically in a law firm overhead is all expenses except for attorney salaries (associate and partners) and benefits. Often overhead is used is various benchmark surveys. However, when determing net income or profit (the profit pool) expenses would include associate salaries and associate and partner benefits. In a professional corporation where officer salaries are expensed we typically add shareholder salaries back to the net income figure to determine the profit pool for benchmarking purposes.

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John W. Olmstead, MBA, Ph.D, CMC

 

 

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