How to Estimate Hourly Cost Rates for Better Project Budgeting
AltFee's budgeting feature helps firms forecast the cost and profitability of legal work before it begins. A key component of that process is establishing an estimated cost rate for each team member.
This article explains what cost rates are, why they matter, and one practical approach to calculating them.
Step 1: Understand the Purpose
Most firms are very familiar with hourly rates — the public rates charged to clients for legal services.
A cost rate is an internal estimate of what it costs your firm for a particular team member to perform one hour of legal work.
When combined with a project budget, cost rates allow AltFee to estimate:
- Projected labour cost
- Projected project profit ($)
- Projected project margin (%)
- Individual contribution by team member
The purpose of cost rates is to support better pricing and budgeting decisions—not to replace your firm's accounting or financial reporting systems.
Step 2: Understand the Difference
Think of hourly rates and cost rates as serving two different purposes.
Hourly Rate | Cost Rate |
What the client pays | What it costs your firm |
Revenue | Cost |
Client-facing | Internal planning |
Example
Senior Associate
- Hourly Rate: $425/hour
- Estimated Cost Rate: $125/hour
If the project budget allocates 8 hours to this lawyer:
- Revenue: $3,400
- Estimated Cost: $1,000
- Projected Contribution: $2,400
Step 3: How to Calculate a Cost Rate
There is no single "correct" methodology for calculating cost rates. Most firms develop a reasonable estimate based on the annual cost of employing that individual.
A common starting point is:
Annual Salary + Benefits + Employer Payroll Costs + Allocated Firm Overhead
÷
Productive Hours Per Year
=
Estimated Hourly Cost Rate
Step 4: Choosing Productive Hours
One of the biggest assumptions in any cost rate calculation is determining the number of productive hours worked annually.
Many firms use:
- 1,300 productive hours
- 1,500 productive hours
- 1,700 productive hours
Others simply use their annual billable hour expectations. There is no universally correct number. The most important consideration is applying the same methodology consistently across your team.
Step 5: Determining Firm Overhead
Another important decision is determining how much overhead to include. Some firms allocate only direct employment costs. Others include a proportionate share of expenses such as:
- Office rent
- Technology and software
- Administrative staff
- Insurance
- Professional dues
- General operating expenses
The key is selecting a methodology that reflects your firm's objectives and applying it consistently across all team members.
Step 6: Review Cost Rates Periodically
Cost rates are estimates and should evolve as your firm changes. Consider reviewing them when:
- Salaries are adjusted
- Benefits change
- Firm overhead changes materially
- Staffing levels change
Example Calculation
Sarah — Associate
(Annual Salary: $120,000 + Benefits & Payroll Costs: $18,000 + Allocated Overhead: $42,000 + Total Annual Cost: $180,000)
÷
Productive Hours: 1,500
=
Estimated Cost Rate: $120/hour
Frequently Asked Questions
Should partners have cost rates?
Yes. If partners are included within project budgets, assigning them an estimated cost rate allows the budgeting tool to more accurately forecast project costs and profitability.
Should bonuses be included?
If bonuses are a regular component of compensation, many firms choose to include an estimated annual bonus when calculating cost rates.
Should overhead be allocated equally across everyone?
Not necessarily.
Some firms allocate overhead equally, while others apply different assumptions based on role or compensation. Consistency is generally more important than the specific methodology selected.
What if we don't know our exact overhead?
That's okay.
The budgeting feature is intended to support planning and decision-making—not financial reporting. A reasonable estimate is often sufficient to generate meaningful budgeting insights.
Can we change cost rates later?
Absolutely.
Many firms refine their assumptions over time as they gain more experience using project budgets and profitability reporting.
Important Reminder
The budgeting feature is designed to support pricing, budgeting, and profitability forecasting.
Cost rates are internal estimates only and should not be interpreted as accounting figures or financial statements.
A consistently applied methodology is generally more valuable than attempting to calculate a perfectly precise cost rate.
Related Articles
To get the most out of Budgeting, we recommend reviewing: