In this issue, I want to talk about budgets and cash flow. The last thing I want to suggest is busywork to satisfy a bookkeeper or accountant. A budget is all about your enhanced ability to know and influence what is going on with your numbers.
Yes, gross fees are difficult, if not impossible, to predict. I believe that you can estimate a usable number based on prior years, taking into account the present matters that are active and likely to settle this year.
Why do a budget? Because you deserve to have worthy goals to reach for and achieve. You deserve to be better able to spot expense irregularities, and you deserve to act as the executive that you are for your firm. A budget is a plan for the acquisition and use of resources for a specific period of time. It is the tool that enables you to keep score against your expectations for the year. You are entitled to know how fees and expenses vary when compared with their respective budgets developed at the beginning of the year. The overarching goal, of course, is to increase fees collected and to decrease expenses paid, compared both with those actually achieved last year and with the adopted budget.
If you have staff, be sure to include them in the budgeting process you institute. Ask staff to estimate costs for office supplies and other accounts. Inclusion can increase an employee’s willingness to assume responsibility and encourage creative problem solving. Develop a realistic budget for your firm, and consider offering incentives to those who work for the firm if they offer ideas that save expenses or increase revenues.
HERE ARE SEVERAL METHODS FOR PREPARING A BUDGET:
Good Method (aka “McBudget”): Look over last year’s tax return and use the law firm fees and expenses you reported last year as this year’s budgeted amounts. While simplistic, this method gets you going with numbers that include a measure of reality.
Better Method: Determine how much money your law practice must generate to support you personally and enable you and your members to prosper. To these two numbers add the total costs of the law practice. The total becomes the total fees of your law firm budget.
Below is an example of a solo practice budget:
|Lawyer’s Personal Income Needs|
Effort to Prosper
Expenses of the Law Office
|Fees Necessary to Collect||$150,000|
Another way to understand the $150,000 is to figure that this amount equals 1,000 hours of collected time at $150 per hour. This number implies working about 1,200 hours on billable files. For expenses, use last year’s expense amounts.
Best Method: Examine each account for last year and think about how volatile those accounts will be in the coming year. Note your assumptions about why an account may change significantly (i.e., more than 20 percent).
|Account||Volatility Assumptions||2012 Budget|
|Rent||Same as 2011||$18,000|
|Malpractice Insurance||Slight increase||$2,500|
|Website / Marketing||Increases||$5,000|
|Telephone / Internet||Same||$3,600|
|Other||Estimate @ $208 per month||$2,500|
|Net to Lawyer||$132,800|
The above expense budget assumes no staff costs. As the year progresses, the difference between a budgeted number and an actual number is called a “variance.” A variance also compares amounts between this year and last year, this month and last month, or this quarter and last quarter. Knowing what your assumptions were helps greatly to understand the variances. Software programs such as Quicken and QuickBooks produce the reports very easily, do the math and can provide expense reports by vendor.
A RIVER OF CASH
Determine how much cash you need (your “cash flow”) to operate your practice and when you will need the cash. There are four sources for financing short-term cash needs:
- Cash reserves accumulated from prior months’ surplus cash
- Bank loan or line of credit
- Vendor credit
- Credit cards
Do not deposit fee advances to your general office account or remove them from the client trust account in advance of being earned. Likewise, do not allow earned fees to accumulate in the client trust account as a method of accumulating a reserve fund. Do not get to a position where you need new advance fee deposits from new clients to finance existing work.
Other methods of accumulating cash reserves, in addition to retaining prior months’ surplus cash flow, is to reduce expenses, speed up collections and negotiate extended payments to vendors.
Loans may come from banks, credit cards, relatives or friends. Present rates of interest are historically low and therefore bank loans are an attractive source. A contingent fee practice will often necessitate availability and use of a line of credit from a commercial lender. I generally recommend that every firm have a commercial line of credit readily available. Advance notice from your cash flow projection of the need to borrow money will allow you time to research the best source of funds and negotiate the amount, terms and interest rate best suited to your practice. Such good cash-flow planning and your business plan will impress your banker…and bankers can refer clients.
Remember that the use of credit cards is the most expensive form of credit. Use the cash advance feature on a credit card only as a last resort.
Personal savings are not a funding source option that I recommend. Savings are your personal reserves and should not be used to support your law practice. Reserve your personal savings for personal needs.
No matter what type of fees you charge—hourly, fixed, contingent or some variable—implement a software timekeeping and billing system. Enter the time for each task you perform during the day whether it is billable or nonbillable time. There are low-cost products available. Stay tuned; in our next issue, I will talk about time and billing.