October 23, 2012

A Financial Checklist for the New Solo Firm

Issue Cover Law Practice Magazine Logo


Rising to the Challenge




By David Bilinsky and Laura Calloway

So you've decided to fly solo and open your own law office. Congratulations! At the beginning at least, your practice will resemble an ultralight plane more than a Boeing 767—which is a good thing because it takes a whole lot less lift and thrust to keep an ultralight aloft.

To help you put your new aircraft on the right heading from the get-go, let's explore the essential financial systems and reports that will serve as your altimeter and your airspeed indicator and keep you flying on a smooth course.

Your Business Plan

Think of this as the flight plan for your new practice. It involves planning your practice on paper, in much the same way that any flight is charted on paper before the wheels ever leave the ground. Following are the essential elements to cover in your business plan.

Practice description. Include the type of legal services to be provided; office location; form of organization, such as sole proprietorship, general partnership, limited liability partnership, professional (or, in Canada, law) corporation, or limited liability corporation; reasons people will seek your services; and your overall business goals. Don't forget to include an analysis of the competition, such as weaknesses of the existing legal services providers in the targeted area and how you plan to exploit those weaknesses to make your services distinctive and grow your business.

Marketing plan. Describe your target clients as well as how you plan to reach them.

Operating procedures. Include your office procedures and systems; physical plant description, including layout of the office; required equipment list; and target-client-mandated amenities such as elevators, lots of parking or proximity to public transportation.

Staffing needs. Include job descriptions outlining the skills necessary for running your office and how those skills will be procured—whether through hiring full-time or part-time employees or contract labor, or by employing technology-driven alternatives such as Internet-based dictation and typing services.

Insurance needs. Include malpractice coverage, of course, but don't forget about coverage for your equipment and health insurance for yourself, too. Business interruption and disability insurance are also good bets for solos.

Financial plan. Your financial plan is also a crucial part of your business plan and should include the following components:

  • Initial balance sheet. This outlines the assets and debts with which you will begin your practice.
  • Estimated overhead and draw. The sum of these amounts will be your total expenses for the year. Divide this amount by 231 (the average number of working days per year) to arrive at the figure you must bill daily. Divide that by the number of billable hours you wish to work per day to arrive at your hourly billable rate. Remember that to continue receiving your draw at the forecasted rate, you must monitor your billable hours to ensure that you're logging (and billing and collecting) what it will take to stay on your "flight path."
  • Breakeven analysis. List your sources of cash for all periods from your start-up date to your projected break-even date. Describe how you will repay these sources once your practice turns a profit.
  • Three-year operating budget. To begin, detail anticipated income and expenses by month for the first year. Create line items for all costs, including salaries, insurance, rent, loan payments, taxes, marketing costs, accounting and bookkeeping costs, payroll expenses, utilities, professional dues and subscriptions, repairs and maintenance costs, continuing legal education and anything else you can think of. And spend more than a little time thinking. This is like taking the time to pack your parachute carefully. You never know when it will pay off.

Then describe your budget by quarters for the second and third years. Estimate all fixed and variable costs, factoring in a percentage increase for fixed costs and variable costs that are dependent on the volume of business. Don't forget to factor in cash-flow lags and the inevitable write-downs and write-offs. Formally state all assumptions on which cash flows are being based, including anticipated clients, billings, salaries, income, collections and write-offs. If your actual earnings don't meet your estimates, you'll need this information to determine both how you got off course and how to correct the situation.

Pro forma income and expense statements. Here's where you pull together all the assumptions that go into your budgets, to produce a bottom-line analysis of whether your proposed new practice will fly. If you've planned carefully, your first end-of-year income and expense statements will match your pro forma ones—and they'll show black ink.

Key Financial Reports and Ratios

Your financial system must maintain all the records required by your jurisdiction's ethics rules. In addition, you'll want to be able to obtain certain crucial information that will let you know that you're flying at the right altitude, in the right direction and well above the tree line. Once you're up and running, you will also want to keep on top of certain financial indicators that reveal the true state of your financial health.

Your cash flow statement is one of your key financial reports. It should (1) detail the inflows and outflows of cash into your practice each month and (2) compare those amounts to your budgeted amounts. You can't afford to run your practice from a negative cash flow position for any length of time, so you should watch this statement carefully.

We also advocate that you look at the following information regularly.

Billable time (actual vs. budgeted). Make sure that your time and billing system produces an up-to-the-minute billable timesheet. You need billable time records not only to keep on track for your budget (and draw) but also to do any meaningful profitability analysis.

Work in progress (WIP). Bill all files monthly to ensure that your WIP on all but contingency-fee files does not balloon beyond 30 days. Unbilled time is money you can't spend—and may have to borrow.

Accounts receivable aging. Someone once said that an account over 90 days is not a receivable—it is a prayer. Accounts sit uncollected for an average of 105 days after billing, but tightening your intake procedures can move you below that average.

Unbilled disbursements. These represent funds that could otherwise be used for operating expenses. Bill monthly (if not more often), and whenever possible, pay them from retainer funds in trust.

Effective hourly rate (EHR). Divide the amount collected on a case by the total hours logged (not just billed). Compare the results with your standard hourly rate. List all matters that produce less than your standard hourly rate and ask yourself if you can ethically and legally ask these clients to take their matters elsewhere.

Realization rate. This is the percentage of your fees that are collected. If you bill by the hour, you should be collecting 95 percent of fees billed. Less than 90 percent realization indicates that you have problems with your collections and, therefore, your intake procedures. If you bill on contingency, you should be collecting 150 percent of your fees, to take into consideration the fact that some contingency matters are lost.

At least once a year, you should compile lists of your high-EHR clients and your high-fee clients. Compare who is at the top—and at the bottom—of both lists. Ethically and legally ask the clients who are at the bottom of both lists to find another lawyer—you're not being profitable on these files and your time will be best put into other legal matters. Consider changing your client intake procedures to focus more on the types of clients or areas of practice that are at the top of both lists. And remember, carefully drafted intake forms are about more than collecting the information necessary to launch a file—they help manage risks by allowing you to identify if a client has the financial capacity to justify the extension of credit or exhibits any of the behaviors that ring warning bells.

Consider the intake form an important part of your overall financial system—and think the same way about your retainer agreement, too. Your retainer agreement is your first and best opportunity to let your clients know your financial expectations of them. There is, after all, little point in performing work on files for which you will not be paid.

Lastly, a few words about trust accounts. If you plan to receive and hold any funds from clients or third parties (particularly retainers), you must maintain a trust account. Properly used, your trust account can also be a great tool to limit your receivables and keep yourself in a positive cash flow position.

At least monthly, on a file-by-file basis, compare your WIP with the amounts in trust held in retainers. If you're starting to exhaust a retainer, then you have a decision to make: You can continue to work on a file for which you may never be paid, or you can insist on replenishment of the funds in trust before continuing. This will keep you from reaching the point beyond which you cannot ethically withdraw from the case, even if the client can't or won't pay one penny more.

Accounting and Practice Management Software

Now that you've gotten the "what," here is a little information about the "how."

You should buy a good case management software package and use it from day one. Case management software draws together your desktop calendar, your contacts list, your filing system, your to-do and deadline systems, your timekeeping system and your communications (correspondence, e-mails, phone calls, voice-mail messages and phone notes) and wraps them up into one desktop application. The result is that you have one program that provides the essential systems required to practice law.

The latest trend is to fold the accounting system in with the practice management system, too, creating an integrated package that looks after both the financial and the operational sides of your practice—all from one database. There are lots of different products available. Regardless of which one you choose, choose one! There will never be a better time to organize all the functions of your practice into a cohesive whole than at the beginning.

So there you have it—a quick overview of what's involved in the start-up of your solo practice from a financial perspective. Stay above the financial clouds, and you will find the experience of flying solo to be a rich and rewarding one.