Why Is the Difference between Hard Costs and Soft Costs Important?

In the course of doing legal work for clients, many law firms end up covering hard costs and soft costs for their clients. It’s common to ask for reimbursement of hard costs, but approaches to soft costs differ.

Whichever approach your firm chooses must be addressed in the client agreement. To make sure you have every base covered, it’s essential to understand the difference between the two—as well as the “why” behind how your firm treats soft costs.

Below, we discuss differences, considerations, and what to think about including in your client agreement.

Understanding hard costs

Hard costs are external and therefore more apparent than soft costs. Hard costs are expenses that a law firm covers for a client during the course of doing legal work for them that must be paid to a third party.

For instance, hard costs can include filing fees, mediation fees, court reporter fees, hearing transcript fees, and fees charged by other experts. They also include travel expenses and medical records.

Notably, hard costs aren’t deductible as a business expense.^[1] This means that if they aren’t captured on the client invoice, then the law firm will end up having to eat the expense. For this reason, most law firms’ client agreements address hard costs as expenses that the firm will ultimately get reimbursed for by the client.

So long as they’re aware of this aspect of the agreement heading into the working relationship, clients generally understand that their bills will include the hard costs the law firm has already paid for them and needs to be reimbursed for.

How soft costs differ

Soft costs, however, are indirect, or “in-house” expenses. They clearly stem from working with a client, but they aren’t paid to an outside source or vendor and therefore aren’t something the law firm will have a separate receipt for.

Examples of soft costs are legal research materials, word processing fees, and copy costs. All are directly attributable to a client matter, but the cost of them is covered as part of the law firm’s general overhead. In other words, the firm isn’t making a separate payment for them.

Most firms will want to address soft costs in the client agreement. Here, there are a few paths. Some firms choose to bill for itemized soft costs as they would for hard costs. After all, these are trackable expenses that can be attributed directly to a client matter.

Yet there are also firms that choose not to take an itemized approach to billing. Instead, these firms add a percentage fee to every invoice so that they are still reimbursed for soft costs, even if they don’t itemize these expenses.

Finally, some firms just eat the cost or fine-tune their rates to account for it.

Keeping the client agreement consistent with automation

Whether you choose to bill for itemized hard costs and soft costs or hard costs and percentage-based soft cost expenses, these details must be reflected in the client agreement that precedes any new matter.

In general, what is most straightforward is to pick one approach and apply it to all your clients. With itemization, you can offer clients slightly lower rates but will need to make sure itemized soft costs are accounted for on the client’s invoice. With the percentage approach, you effectively charge higher rates—though you’ll still want to track your soft costs. (More on that below.)

Whichever approach you choose, it’s important that your client agreement consistently informs clients how your firm approaches the billing process. This can be done through automated document generation.

With automated documents, you first need to create a template. Then you can simply import the client’s specific details and information from your practice management system.

Automated generation is more streamlined than copying and pasting because you don’t need to remember which fields need to be updated—the system does it for you. Likewise, if at any time you update your client agreement template, you know those changes will be included in all new agreements you sign with clients moving forward.

Your practice management system’s automated document drafting process makes it easier to provide a more consistent product for clients.

Tracking costs

No matter how you bill, you’ll need to track hard costs, at minimum. This task doesn’t need to take up much time, though.

If you use a cloud-based practice management system, it should come with a mobile app that lets you track time and expenses on the go. This means you don’t need to worry about trying to remember something once you’re back at your desk. You can simply put in the information as it happens on your phone.

Likewise, a good practice management system will be able to import your law firm’s credit card statement so that you have a second safety net for noticing and capturing hard costs that appear on the bill.

If you bill for soft costs, on-the-go tracking makes that a straightforward thing to do, too. Noting the number of copies or use of legal research materials can be accomplished in a few quick taps on your phone.

And even if you don’t bill for soft costs, there’s an argument for tracking them anyway. From a budgeting perspective, it’s important to understand what it costs your firm to complete a matter so you can set pricing accordingly.

Let your practice management system keep it straight

Your practice management system should be able to address the differences between hard costs and soft costs in your financial statements and billing.

If you use a single platform for your billing and accounting, plus on-the-go tracking, accurately capturing hard costs and soft costs should be a straightforward process. Not only will they end up on your client bills, but they’ll also automatically be reflected in relevant accounting statements.

And if you choose not to bill for soft costs or take a percentage approach, your practice management system should be able to support that, too.^[2]

Ultimately, any tech you use should simplify your work life. From billing for reimbursable costs to mobile tracking to automated document creation, you can—and should—ask a lot from a single tool. After all, your time is valuable, and your practice management system’s effectiveness should reflect that.

References

1. To All My Law Firm Friends… Let’s Talk about Advanced Client Costs
2. Questions on e-Discovery Cost Recovery, Answered (Part I)