Every law firm should maintain an internal budget/forecast and update that document on a monthly basis. An annual forecast of the firm’s expenses and revenue should be prepared a month or so before the end of the previous year. Each year is different and may have different expenses, so it is unrealistic to use the same forecast every year.
Owners of a firm do not want any surprises that could be avoided by properly recording expenses and revenue. No business owner wants to deal with an emergency due to lack of planning.
Most firms are on a modified cash or cash basis accounting platform. Essentially, revenue and expenses are not recorded unless they were received and paid.
How To Get Started
Most time and billing applications offer accounting software to provide required information to build and maintain a budget. If your time and billing provider does not offer any assistance or solutions, a budget can easily be prepared using a spreadsheet for the short term. Eventually, the time and billing provider should provide easy to understand financial statements that can be readily prepared.
A solo attorney should not have to spend any more than 1-2 hours a month reviewing budget and forecast. It makes sense to delegate preparing and updating the forecast/budget.
Revenue
How much revenue (cash receipts) does the firm anticipate on a monthly basis. If the firm employs paralegals or other billers, it is important to incorporate those billed fees.
Every month, the actual cash receipts should be recorded, and budgeted cash receipts may need an adjustment. For instance, if the firm acquires a new client, the revenue should be increased and vis versa. If the firm loses a client or the client does not have a legal need, revenue must be reduced.
If this is a new entity, look at current clients and what bills are expected to be generated. It is important to calculate a realization rate. Many firms realize 85% cash receipts of invoices.
Expenses
It is best to put expenses into categories so they can be benchmarked against industry norms. For instance, real estate expenses should be in its own category and should not be more than 7% of revenue. In the real estate category, include rent and any operating expenses associated with real estate. For instance, if the firm needs to reserve a conference room space regularly and is charged separately for that rental, it should be included in the real estate category. Or, if the firm is paying a mortgage or other real estate taxes.
Employee expenses are usually the largest expense a law firm incurs. In some firms, it can be more than 40% of revenue if non equity partners are employees and not partners. It is important to list every employee’s salary plus out of pocket expenses such as medical insurance. If an employee is being recruited, include that new employee’s salary along with any recruiter fees incurred. Make sure that year end bonuses or annual raises are incorporate in that expense.
Technology expenses are increasing with the new hybrid work models. Include all cloud expenses, telephone, internet, outsourced technology support. A firm can expect to spend approximately 5-8% of its revenue on technology.
Marketing and client development are also increasing with the hybrid work environment. Include all networking groups, advertising, media costs, website maintenance, professional events and publication subscriptions. When attending a conference, be sure to keep copious records to ensure all tax deductible expenses are recorded. Firms are spending about 5% of their revenue on marketing. This depends on the type of law a firm is practicing. For instance, a personal injury firm probably spends more than 25% of revenue on marketing efforts.
A category listing all insurances, licenses and professional development should be included. A firm wants to ensure that professional liability and cyber insurance is within the average cost in the industry. Make sure any professional development (i.e. courses, coaching) are included. This expense usually accounts for 2-4% of revenue.
Other expenses can be combined such as automobile, gas, car insurance, office supplies, legal research, postage and bank charges. These “other” expenses should not be more than 5% of firm revenue.
Review
A budget/forecast report is for the benefit of the owners of the firm. It provides the owner a monthly snapshot of how the firm is doing. It is a great tool to forecast any potential issues. For example, if offices supplies are increasing every month, it might make sense to investigate.
This report helps owners not “set it and forget it.” It also provides needed information if a firm is contemplating a large expense.
A firm’s accountant would very much appreciate receiving a budget/forecast on a monthly basis. Yes, the accountant provides actual revenue and expense items, but the budget combined with the actual activity provides insight for all involved.
Published by Zola Suite 12/10/2021