An age-old joke goes something like this: a person walks into a bank and says, “How can I not have any money, I still have checks left?”. Although checks may be unfamiliar to some younger generations, the comparison between revenue and income is akin to this difference. A firm can have a large amount of revenue, but in the long run, the amount of income determines what is available to pay bonuses and invest back into the firm. So, what is income and how does it differ from revenue?
Difference Between Law Firm Income vs. Law Firm Revenue
Revenue is the amount collected by the firm. Revenue generally comes primarily from client work but may come from other sources as well. Income, or often net income, is the revenue earned minus the expenses incurred. Income is reflected on the firm Income Statement, also called the Profit & Loss Statement.
Expenses can be operating expenses or overhead expenses.
Operating expenses are those the firm incurs as a result of normal operations. This would include client costs, salaries for those working directly for the clients, copiers and supplies.
Overhead expenses are what it costs to run the firm including rent, insurance and utilities. Salaries for marketing and HR would also be considered overhead expenses.
Law Firm Revenue
For a law firm, the primary source of revenue will be income from client work. This could be based on hourly billing, flat fees or settlements on contingency cases. The firm may also have revenue from reimbursement for client costs as well as receiving referral fees from other firms. A firm may also have income from other sources that aren’t part of the legal practice, for example, rent income from sub-letting space or being a landlord.
Keeping track of different sources of income can help the firm understand what areas of work are bringing in the most revenue. The most revenue dollars are not necessarily the most profitable source of revenue.
Revenue from client costs can also be divided. When the firm lays out money on behalf of a client, this is an advanced client cost (referred to as hard cost) and is a loan to the client. When the client pays the firm, or the firm collects reimbursement through a settlement, the cost is repaid. Tracking this on the balance sheet, rather than on the Income Statement, helps to prevent large ebbs and flows in income based on case expenses. For certain types of cases, the IRS requires this treatment.
The other type of client cost is soft costs. Soft costs are expenses incurred for a client but not directly paid. This would include items such as postage on the postage meter or copies from the copier. When these costs are repaid, the firm is receiving revenue regardless of whether the soft costs are billed directly or the firm charges a fee to cover these costs.
How to Calculate Law Firm Revenue
Law firm revenue can be tracked and measured in many ways: by client, practice area, billing type, working attorney, or responsible attorney. To enable compensation to its members or for other firm measurements, a firm may require multiple revenue tracking methods. The firm may also get revenue from non-client sources. The total revenue of the firm involves all sources, but when calculating compensation or determining the profitability of a type of law, these additional sources are generally not relevant.
Law Firm Income
The profitability of a type of case is based not on revenue but on income (revenue minus expenses). If two cases both brought in $10,000 in fees but case A involved $5,000 of attorney time and case B required $4,000 of attorney time and $2,000 of paralegal time, case A is more profitable. In this example, the income for case A was higher than for case B, even though the revenue was the same.
Similarly, if both cases involved the same amount of time but one case required a referral fee, the profitability of that particular case would be lower and it’s crucial to compensate those involved appropriately. The compensation of attorneys is a significant expense. Firms compensate attorneys differently but unless they are paid purely on salary, it is important to know the actual income of a case, not just the revenue. Compensation based purely on revenue, without factoring in expenses, can lead to financial issues as the firm may not be left with enough money to pay overhead.
How to Calculate Law Firm Income
In calculating income at the firm level or the matter level, you need to make sure all costs are properly allocated including hard and soft costs and other expenses like referral fees. You also need to make sure all revenue sources are properly tracked and allocated. If income is not properly tracked, it may impact calculations for compensation and tax calculations. For example, a particular attorney may be due compensation for a referral fee received on a matter.
How can you calculate income?
Using a billing and accounting system tailored for legal professionals can simplify the process. When the firm generates an invoice and receives payment, the system can make sure that the income is properly allocated to fees and costs. Overhead costs would be in the same system so the bottom line will show on the Income Statement. This lets the firm know how much the firm is actually making. A single system can help in tracking the financial picture for the entire firm but also in looking at income in different breakouts (attorney, practice area, etc.).
The Role of Financial Management in Law Firm Growth
When evaluating law firm software, it’s important to think about what measurements are needed to manage the firm and to compensate members of the firm. Choosing a legal practice management software that can provide the essential measurements can save valuable time and money, along with planning growth for the future.
Written by CARET Legal partner, Caren Schwartz. Caren has dedicated nearly three decades to addressing the technology needs of the legal industry, currently leading the accounting services team at 3545 Consulting. Her expertise centers on back-office services, analytics, and best practices for law firms. Caren possesses extensive knowledge in Time, Billing, Accounting, Practice Management, and Document Management tailored specifically for legal practices. She frequently speaks on optimizing legal time and billing systems, helping law firms enhance their efficiency and effectiveness.
