Law firm leaders understand the concept and importance of profitability. Nevertheless, in many practices, expenses and revenue are not reviewed on a regular basis. While your firm may be focused on other aspects of maintaining business, it is imperative that steps are taken to ensure your firm continuously reviews its finances and expenses.
Start with a Budget
A budget can be easily prepared and updated on a monthly basis. It will provide a snapshot of how a firm is performing. It is not sufficient to just check credit cards and checking account balances. It would be wise to task someone to prepare a budget and update it monthly. Have them reach out to the firm’s accountant for monthly financial statements and input these numbers into a basic budget. It is best to start a year or fiscal period with 12 months of estimates/budgets. Include line items for fees, realization rate, employee costs, facilities, professional development/insurance, marketing, technology, and other expenses. The industry has reviewed these categories and has benchmarks of what should be spent for each. For instance, a firm should only spend between of its revenue on facilities and related expenses.
Have the accountant provide a profit and loss statement every month, by which the law firm can update its budget/forecast. Each month, input actual data, so at the conclusion of the month of March of any year, a firm can easily review the first quarter of actuals and nine months of estimates to determine if it is making its revenue target and if expenses are in line with what was expected.
When a firm is just starting, a budget/forecast is critical. Keep in mind that revenue may take up to three months to be received. Work has to be performed and billed, and invoices must be paid. Some expenses may be a “one and you’re done” expense (i.e., furniture). Some are recurring monthly expenses like subscriptions or rent. The owners should expect and plan for delays in compensation, but ideally these delays should last only a short period of time while the business gets up to speed. Thereafter, a regular stream of revenue must be realized to succeed.
Review Your Budget/Forecast
By reviewing expenses and revenue on a monthly basis, owners will recognize when there are unexpected expenses, or when revenue is not what is expected. A firm can also hire someone to do this work to save some time each month.
Revenue is considered all cash received for work that has been completed. Do not include escrow/IOLTA funds in the budget. Those funds are the clients’ until earned. Rules of Professional Conduct in each state clearly state how to handle IOLTA funds.
Remember that invoices sent to a client do not reflect revenue, cash receipts do. It is not only important to review revenue, but to review accounts receivable as well.
If revenue drops dramatically in a month, it may be because a large invoice was not paid or a large invoice in the previous month was paid sooner than expected. It may also be due to losing a client a few months earlier. Similarly, if an expense category is significantly different than expected, it is important to review all the expenses associated with that category so the anomaly can be identified.
Some purchases may be considered capital purchases and depreciated over time. When preparing and maintaining a budget/forecast, be sure to include the entire amount spent so income expectations are realistic. It is prudent to project income and expenses conservatively. It is also important to make sure that the firm maintains some financial cushion in case of an emergency.
Benchmark Revenue and Expenses
In setting expectations and your budget, it’s helpful to reference legal industry benchmarks and analyses, such as Revenue Per Lawyer, Profit Per Partner, and Net Income. Be aware that some of these statistics can be manipulated. For instance, to have a high Profit Per Partner ratio, some firms will select poor performing partners and de-equitize them prior to reporting their statistics. Review these statistics which are published through local bar associations, select media and the ABA (American Bar Association). Also, discussing benchmarking data with trusted colleagues may be helpful. Realize that these statistics change frequently. An annual review would be prudent and worth the time invested.
In trying to maximize revenue and decrease costs, it might be tempting to increase client rates or pay new hires less, but take caution in doing either. A successful law firm does not want to overcharge a client; nor does it want to undercharge. Therefore, it is important to monitor billable rates. Firms that have employees should pay them market rates. To replace a talented employee usually costs three months of that employee’s salary. It is expensive and a cost that is difficult to quantify; therefore, retaining top talent is more cost efficient.
A law firm is a for-profit business entity. A healthy firm will provide an expected income for its owners, which includes a work/life balance. Owners cannot work eight days a week. It is also important to keep a law firm financially healthy so it will be attractive to possible laterals. There may also come a time when the founding partner(s) will want to sell the firm. It is important to keep it financially attractive to potential buyers. Regular reviews of your revenues and expenses is integral to the success of your law firm today and well into the future.
Published by Zola Suite September 10, 2021