Do You Need Timesheets to Determine Profitability?

Tom Kane of the Legal Marketing Blog posted Has Your Firm Tamed that Damn Billable Hour Yet? last week. He says,

• You can’t make a profit on fixed fees unless you know what your costs are;
• You can’t know what your costs are unless you know how much time (and other dollars) are consumed by the matter; and
• There is no way to know how much time is being spent on matters if you don’t keep track of hours!

Duh!

Tom isn’t alone in thinking this way. But I challenge that ‘Duh!’ the idea that you need timesheets to determine profitability. I left a comment on Tom’s post issue because I think it’s one of the huge misconceptions that lawyers buy into – you need timesheets to determine whether you’re proftiable.

It just happens that there’s been a heated discussion about this very issue on a couple of legal list-serves over the past few weeks. Some of the discussion focused on calculating the profitability of a fixed fee engagement vs. the profitability of the same engagement when billed hourly. Other portions of the discussion revolved around overall profitability.

Here’s an example of how the timesheet as measure of actual time (and therefore a component of profit) falls apart in terms of comparing fixed fees vs. hourly:

At this point I shave my billing quite a bit. I may spend four hours on something and then I think it really should have only taken me two hours and I end up billing for one hour because the client’s total bill seems a little high.

The above is an actual quote from a lawyer participating in one of the list-serve discussions. Many other lawyers chimed in that they do the same. Whether they admit it or not, there are lawyers and law firms that add time to a bill even if they didn’t spend the time – it may be unethical, but it isn’t uncommon.

Whether they realize it or not, the lawyer that adjusts the bill up or down is actually looking at what they think the value of the service is to the client – so they adjust their time up or down to adjust the fee to be more in line with what they ‘think’ the value should be. The result? Often the fee charged really has nothing to do with the hours that were ‘actually’ spent on the engagement, even in an hourly context.

Of course, if you want to track profitability of an individual matter that’s been billed on an hourly basis, what you’d really be looking at is the earned hourly rate, ,which takes into account that you worked three extra hours than you billed for.

But what happens if you’re not billing hourly, but you’re keeping timesheets anyway because you think it’s the only way to measure profit (particularly in comparison to what you ‘would have’ charged if you were billing hourly)?

When you compare the hours reflected on the timesheet with what you were actually paid by a client on a fixed fee engagement, what adjustments do you make to the time on the timesheet? Do you mark down or mark off (or mark up) the same time that you ‘would have’ if you were billing hourly? Or are you simply multiplying hours by the rate you ‘would have’ charged? Can you really make an accurate determination of profitability this way?

Next, consider the difference between billing hourly and getting paid after the work is performed with billing on a fixed fee basis and getting paid up front. With the hourly bill, there’s no guarantee that the client is going to pay your entire fee. In other words, the fee *paid* may also not be in line with the time spent. Do you take that into consideration when you’re making your profitability comparison, or are you just assuming that if you had billed hourly based on your timesheets, that the client ‘would have’ paid the full amount?

Again, if you’re determining profitability on an hourly billed matter, what you’re actually paid (as opposed to what you charged) will be factored into your earned hourly rate. But the hours that you spend on client work aren’t the only hours you work. If you really want to determine profitability, and you really think that time is a component of profitability, you have to take into account all of your hours. The problem is that a good number of those hours aren’t allotted to any particular client, so they won’t be factored into the equation when determining profitability of an individual matter.

For those of you that think that timesheets are a valuable tool to determine profitability – are you keeping track of all of your ‘non-billable’ time, whether it’s tied to a specific engagement or not? If time is such a big factor in profitability, when you’re considering the overall profitability of your practice (as opposed to the ‘profitability’ of an individual matter or engagement), you have to take all of that ‘non-billable’ time into account.

How do you measure the profitability of the hours you spend doing business development? Do hourly billing lawyers consider all of the hours spent reviewing timesheets and adjusting your bills in your profitability equation? Are you considering mentoring, staff management and other time in your profitability assessment?  Even lawyers that say that they keep track of their nonbillable time don’t do so as meticulously as they do with their ‘billable’ time. How do you account for all of the time that isn’t reflected on a timesheet?

Most lawyers think keeping track of time helps them with profitability assessments because they can look at the revenue received and divide it by the amount of time spent on the engagement, but what does that do? It gives you the idea that you ‘make’ $x per hour, or that it ‘cost’ you x hours in order to make $y. How, exactly does that show whether you were ‘profitable?’ What is the actual ‘cost’ to you of those hours?

In other words, if you believe that time is a cost, is it a fixed cost? If you aren’t billing hourly, how do you determine how much an individual hour is worth? Are all hours worth the same in calculating profitability? Is the hour spent cultivating a client relationship worth the same as an hour spent preparing a letter or cross-examining a witness? What about an hour spent filling out timesheets? Or an hour surfing the internet? Do you calculate the value of an hour in terms of what revenue that particular hour could bring in, or do you calcuate it in other ways – such as the stress it may have caused, or the perceived difficulty of that task for you? And what about hours spent that might bring revenue from more than one source? How do you calculate the profitability of those hours? Does an hour spent on something you enjoy cost the same as an hour spent on a task you loathe? How does that play into the profitability equation?

All business owners, whether they’re professionals or not, have the same number of hours in a day, a week, a month or a year to work with. Time is a limited resource for everyone – lawyers are not unique in that regard. So how do other businesses tell if they’re profitable without keeping timesheets?

The truth is that profitability has nothing to do with time. The money that the firm pays to its employees, associates and partners are costs. The time itself is only a cost to the individual lawyer, not to the firm or the practice. And even then, as demonstrated above, the ‘cost’ of every hour isn’t fixed. And I’d be willing to bet that most lawyers have a good handle on how much time they spend working, whether they’re keeping timesheets or not.