Building and managing a law firm budget in five steps requires a thorough understanding of firm expenses and revenue that you must monitor with vigilance and adjust as necessary to plan growth and manage cash flow.

1: Understand Your Expenses

First, identify and understand all the firm’s expenses, including fixed costs like renting office space, insurance policies, technology costs, and salaries for employees and partners. It also includes variable operational costs, such as legal research, court costs, travel expenses, and marketing and equity partners’ profit distributions.

Organize the expenses to know your monthly, quarterly, and annual costs. Although somewhat variable monthly and quarterly, the firm’s payments will be more consistent than its income sources and revenue.

2: Track Your Revenue

Second, identify and track all your sources of revenue, including hourly billing, flat fees, retainers, and collected contingent fees. Also, track your accounts receivable to know what is in the pipeline by listing all potential revenue for cases and how the clients will pay, such as automated check handline (ACH), credit card, retainers, and flat fees.

From historical billing information, know the firm’s collection rate, a key performance indicator (KPI). Knowing the firm’s collection rates, including those by practice and attorney, allows you to project income in the following months, quarters, or even years to plan for the firm’s financial well-being.

Once you detail expenses and revenue, you can track another KPI, the firm’s profit margin, and create a budget that provides a roadmap of expected income and expenses for one or more years.

3: Build a Budget

The law firm’s budget is a financial roadmap, showing you what to expect of revenue and expenses, including projected changes, over a given period, often one year. You can forecast change with real-time or near real-time information on client and matter statuses, accounts receivable, and costs, resulting in a different cash flow.

The outcome of cash flows can help you understand cost and revenue projections. Even if the roadmap is what you expect, leave some cash in the bank to plan growth and engage in strategic plans, such as improving technology, marketing campaigns, and adding partners, staff, or practice areas.

4: Plan for Growth

The law firm’s budget should leave room to grow, requiring you to set aside funds for marketing campaigns to attract new clients, invest in professional development for attorneys and staff, or upgrade technology to improve efficiency in managing finances and legal services to clients.

Some budget items that cannot complete in one year require you to build them into future budgets. It would help if you created a strategy for multiyear projects but include these items in the annual budget every year as an ongoing project until they terminate.

5: Monitor and Adjust

Managing a law firm’s budget involves stages of monitoring and adjustment. Regularly review the budget and compare it with actual outcomes of revenue and expenses. Are expenses higher or lower than expected, and is revenue up or down from projections? Asking these questions will help you identify areas of overspending and opportunities to increase revenue and enable you to make necessary adjustments to stay within budget.

At any time, client matters can terminate, clients leave, and projected pipeline deals do not come through. Generally, events impact revenue, but expenses happen. You must effectively manage cash flow to ensure the firm has enough money to cover costs, which can be challenging when dealing with irregular income from contingency cases, late-paying clients, and other factors. It would help to cut costs where possible and use technology to manage the budget and cash flow.

What can you do?

Cut Costs Where Possible

You may need to plan for immediate changes when you review income and expenses. For example, delay or suspend costs, such as putting off the new computer system or postponing upgrades until revenue increases, renegotiate vendor contracts, and reduce unnecessary overhead costs.

When expenses exceed revenue, partnership profits are at risk. You can’t pay partners their profit earnings from nothing. When all equity partners are equal, it is easier to make across-the-board cuts. Partners will take cuts according to their equity position when they are not. But it’s not all cut, cut, cut.

Rather than reducing expenses, look at opportunities to Improve efficiencies where you can. For example, use technology that can help you cut costs.

Use Technology

Most firms use a practice management application and time-tracking, billing, and accounting software to manage the budget. These tools should include features to track and report expenses and revenue and view the firm’s overall financial health in intuitive dashboard graphics or allow you to export the data to business intelligence software.

At a minimum, the firm’s software should know its KPIs, such as the percent and average of billable and non-billable hours, realization rates, collection rates, revenue per lawyer, and profit margin.

If the firm’s software resources don’t include financial features to help you review KPIs and maintain profitability, you should budget to upgrade or replace the software or plan for obsolescence.

Conclusion

The five steps to building and managing a law firm budget are necessary but may not be sufficient for your firm to maintain financial well-being in a competitive market. Many firms have the technology to bill clients accurately, account for revenue, and report KPIs. Still, they lack benchmarks to help them increase profitability and maintain competitiveness in the legal marketplace.

Precise specializes in the business economics of law firms, providing financial services and benchmarks through service models and BI software suitable for firms, corporate legal departments, and legal service providers of any size and practice area. Contact Precise today to learn how it can help you increase profits and improve financial stability.