In a data vault, in Switizerland, behind multiple fire walls and triple locked end to end user encryption, I keep all my most precious documents.
They include the photos I could not bear to lose, the video of my eldest child learning to crawl and my copy of The Expense of Time (4th edition 1992).
This document is the lineal descendant of the Law Society publication Know What It Costs You, published originally in 1967. As far as I know no later document has been released. The purpose of the document is described as follows:
It must be emphasised that this booklet is an aid to efficient management: its application will supply the commercial information necessary for the purpose of running the business of supplying legal services.
Using the procedure described in this booklet will enable you to calculate what each matter has cost you and what profit or loss you have made upon it. It is not a means of calculating the charge to be made to the client.
The “not” is honoured more in the breach than the observance: whenever guideline hourly rates are reviewed an exercise in the expense of time must be undertaken, whether it is given that name or called something else, because although courts these days deal in single hourly rates, that hourly rate is still made up of overheads and profits, and it is necessary to determine both before electing upon a single composite figure.
The publication sets out two methods for calculating the annual expenses of running a solicitor’s firm in order find out what income is needed before any profit is made, to enable it to be seen on a monthly basis, what progress is being made and to distinguish the profitable from the less profitable, or even the loss making by comparing the charge made to the client with the expense incurred. It is no more nor less, than a way of drawing up management accounts. As the guidance notes:
If you have a computer program which has a suitable spreadsheet, then once you have entered the completed calculations from this booklet, you will be able to see instantly the effect of any actual or completed alteration in the expenditure or composition of your firm. Any desired variable figure can be entered and the expense calculation repeated as often as necessary to enable you to see the effect of alternative courses of action. The message to any firm intending to prospect in the rapidly changing environment of the profession will be apparent.
The publication then sets out a fairly simplistic series of calculations which involves determining the firm’s overall overheads and then the more nuanced set of calculations which can be used to discover the annual expense of each fee earner, noting that the distinction between “whole time” fee earners, and others who have management responsibilities or are in training and spend part of their time on non-chargeable tasks, requires an adjustment.
This then permits a set of figures to be calculated which shows the amount each employed fee earner must bill during the calculation period, to cover his own overheads and make a contribution to the interest upon capital employed in the firm. For equity partners, the calculation will result in the amount that each must bill in order to cover his overheads, and his contribution towards to the interest upon the capital employed and to produce the merely notional salary that has been applied to him.
In summary and by way of example, to obtain the firm’s annual expense rate the following steps are taken using a form included in the publication:
1. Set out:
(a) the middle date of the latest accounts and the RPI at that date;
(b) the commencement date for the present calculation and the nearest RPI figure available; and
(c) the future rate.
2. Enter the total expenses which include depreciation, from the accounts.
3. Deduct the amount shown in the accounts for:
(a) rent
(b) salaries and employers proportion of employees NHI contributions and pension contributions;
(c) any special provision in the accounts which will not be repeated in the calculation period, to give at:
4. Total other expenses.
5. Deduct the RPI figure are 1(a) and from 1(b), divide the result by 1(a) and multiply by 100 to find the percentage increase over the period. Increase the figure at 4 by the same percentage to arrive at:
6. Current level of other expenses.
7. Take into account inflation for the period for which you are estimating the expense. This is done by increasing the current other expenses at 6 by the percentage inflation halfway through the period. For a 6 months calculation one quarter of the future rate will be applied, to give at:
8. Projected other expenses for the next six months on an annual basis.
9. Add the annual amount of the following:
(a) market rent;
(b) current salaries and employers proportion of employees NHI contributions and pension contributions;
(c) the notional salary appropriate to each equity partner
(d) interest at bank’s base rate on the total of partners balances in the accounts including reserves but excluding the value shown for office premises;
(e) any special provision for known expenditure additional to that in the accounts eg outgoings on new premises or depreciation or leasing costs of major equipment;
10. Deduct the anticipated retained interest.
11. Projected total expense of the firm for the next six months on an annual basis.
One would then move to apportion the expenses to individual fee earners with a further set of calculations in order to get an annual expense rate for each fee earner.
The point of having an individual fee earner’s annual expense rate is that it can then be used to derive an hourly expense rate, which when considered in conjunction with a record of how much time is spent on any matter, will enable the expense of that matter to the firm to be known in turn.
The publication emphasises an accurate record of chargeable hours being kept in relation to work undertaken. Interestingly the Law Society notes:
Such information as is available to the Law Society, from surveys and other sources, indicates that a reasonable estimate is 1100 chargeable hours per fee earner. However this is an average: some fee earners will not achieve it; others will exceed it.
But this figure-whatever it is-divided into the annual expense rate gives the individual hourly expense rate. This in turn allows a budget to be drawn up and applied with a monthly target, and indeed to judge each month what progress a firm of solicitors is making.
If the monthly or other periodical target is not exceeded, then you will have to find out why that is so. It may be the result of failure to ensure that there is a satisfactory system for recording time spent and that it is properly implemented by your staff: or because fee earners are so busy that they do not find time to put in bills; or because, even though everyone is working busily and efficiently, you are charging too little or undertaking certain types of work which just do not pay; or you are running too expensive an office or your overheads are out of control and should be curtailed.
The work continues to explain the concept of notional salaries for equity partners, and notional market rent, where the partners own the offices.
Notional salaries for equity partners are described as follows:
The figure that is put into the calculation is described on page 7. It bears no relation to the income a principal intends to earn, assuming he wishes to earn more than his senior assistant solicitor. The use of notional salaries allows comparison of expense rates between firms with dissimilar composition but their primary purpose is this; that if notional salaries were not used, the partner’s expense rate would be substantially lower than his employees in the example in this booklet and it would not in fact be possible to calculate the “proportionate to salary” part of the other overheads.
Notional market rent is explained thus:
If your firm pays the full market rent for the offices that it uses, then this figure will appear int he form for annual expense. However, if the partners own the office building but charge themselves no rent, then they are losing the income they would have received had it been let either to the partnership or elsewhere and therefore it is essential to include in the expense calculation an appropriate figure for the market rent of the premises. If this is not done, the expense rate of the firm will be lower than that of a firm which leases its premises at the market rent but which is otherwise the same and, in addition, no proper commercial judgment of the profitability of different types of work can be formed.
As noted above, The Expense of Time was never meant to form the basis for deciding upon hourly rates to charge the client.
But it remains the bedrock of devising a methodology to calculate hourly rates, despite its antiquity.
The Expense of Time can also be viewed as very much a creature of its time: one example is the obsession that the authors have with RPI and inflation and reflects a different age, where inflation could easily be 6% or 7% and interest rates could increase to 15%, figures unheard of in modern times.
Similarly the attempt to build management accounts, apparently a novel concept for much of the profession in 1992, in a pre-digital age is endearingly crude and does not reflect the subtleties inherent in modern accounting practices, nor the effect on overheads of delays in payment, the burden of aged WIP or bad debt arising from failed CFAs.
Those were simpler and perhaps happier times.
Curiously the document and the approach that it espouses, is becoming more relevant and not less as the accuracy of the guideline hourly rates from 2010 is now highly questionable.
In the next article I shall consider how these type of calculations can be used (and abused) on detailed assessments to argue for or against hourly rates.