Importance of Budgeting for Law Firms
Whether you are a solo practitioner or a large law firm, your budget is an important tool for managing the firm’s finances. It helps the firm plan its expenses, identify and reach operational and financial goals and anticipate changes that may need to be made to support the firm, its employees and its clients.
The process of creating a budget forces the firm’s management to take a hard look, not only at costs and expenses, but also at the firm’s goals and priorities, its progress toward reaching those goals and to identify areas for improvement. Having a budget provides the firm with a framework for decision making during the year and guidelines for allocating resources. When unanticipated expenses arise, or when an opportunity presents itself that might require an expenditure that wasn’t planned, reviewing the budget will help you to see whether you can make that payment.
Preparing and regularly reviewing your budget can help the firm determine whether to take on a new practice area, ascertain which clients or practice areas are most financially beneficial to the firm, decide whether to hire additional staff, provide pay raises, spend more money on marketing or whether it is time for the firm to raise its rates or change its fee structure. It helps firms make decisions about where to invest the firm’s revenue to help the firm grow.
Key Elements in a Law Firm Budget
Now that you know you need a budget, what should that budget look like?
Some of the most important elements to consider in your law firm’s budget include:
- forecasted revenue;
- cash flow projections; and
If your firm has been operating for some time, you can review historical data to help you create your projected revenue for the upcoming year. If you are just starting out, you may need to make some educated guesses about anticipated revenue using statistics, information gained from colleagues or other firms and the volume of cases the firm anticipates. When forecasting revenue, it is important to consider the potential that not all clients will pay their bills in full, and that not all hours expended will be billed.
Expenses include all the anticipated expenses for the upcoming year, including the expenses you incur regularly, such as rent, payroll, insurance, utilities and subscriptions and licenses (software subscriptions, for example). But the budget should also consider expenses that might be less frequent, but that you anticipate you might incur in the upcoming year. For example, perhaps you plan to revamp your website in the coming year or purchase new technology for the office. Even if you do not anticipate making those expenses in the immediate future, you may wish to begin planning for those kinds of larger expenses in the future. You may also have expenses for individual marketing activities like sponsorships, business lunches or dinners or conferences (and travel to those conferences). Those items should also be included in the budget.
It is important to take projected cash flow into account when creating your law firm’s budget. Your cash flow will depend on many factors, including your practice area, the kinds of clients you represent and your fee structure. For example, firms that primarily bill on contingency will not see payment until the conclusion of the case, when the outcome is determined. Firms that bill up front, either on a flat fee or on a retainer basis will see their payments more quickly. Those that bill hourly after the work is completed may get paid more slowly and may need to factor in the amount of time it takes to prepare the bill and to receive payment from the client. Firms with less predictable cash flow or longer periods of time waiting for payments may need to consider how expenses will be met during those times.
Tips on Developing Your Law Firm Budget
New to budgeting and not sure where to start? One good place to start is with a template that you can customize for yourself. Many such templates can be found on the internet from sources including state and local bar associations, professional liability insurance companies and others. There are also excellent books available from the Law Practice Division on financial management that can help you with the budgeting process.
When preparing your budget, be sure to involve key stakeholders in the process. They may include not only your partners, but also your office manager or administrator, IT staff, marketing professionals and others.
You will want to refer to historical data if your firm has been in business for some time. Don’t rely solely on the previous year’s records; include data from three to five years, if it is available, so that you can see patterns and trends, such as seasonal fluctuations. Financial data to review when preparing the budget includes fixed and variable expenses, rates, billable hour requirements or expectations, payroll and distributions, debt, investments and current account balances, accounts receivable, realization rates, write-off information and work-in-process, as well as the firm’s profit and loss statements, and past budgets.
But financial data isn’t the only data you should review when preparing your budget. For example, reviewing your client list and comparing the number of inquiries or initial consultations against the number of clients who retain the firm can provide valuable information for your forecasting. Similarly, knowing your firm’s turnover rate can help you predict what costs may need to be incurred in the upcoming year for hiring and training.
Your practice area or fee structure may determine what data should be reviewed when preparing your budget. For example, firms that bill on a contingency basis may need to review settlement data, including number of settlements achieved, average settlement amounts and the average length of time it takes to settle a case.
If you don’t have historical data, you may be able to find information about trends in the industry to help guide you, or you can seek the help of a financial professional.
Review, Evaluate and Adjust
Once the budget is complete, don’t simply file it away until it’s time to prepare next year’s budget. Your budget should be reviewed regularly against the firm’s actual financial performance to see whether the firm’s projections were accurate, goals and targets are being met and to make any necessary adjustments.
If you are new to budgeting or your firm is brand new, you may want to review your budget every month. More established firms may wish to review the budget less frequently. If significant unforeseen events occur, such as the loss of a significant client, an unexpected economic downturn or loss of a key employee, the firm should also review the budget to adjust for the potential impact of those changes.