Law Firm Budget: How to Create Your Financial Strategy
A budget documents your law firm’s financial strategy. It also keeps the business on track, reveals when missteps are taken, and can highlight issues affecting profitability.
Despite the importance of having a budget, many law firms do not follow disciplined budgeting practices. Law firm budgeting can present challenges that seem insurmountable, and without the right tools in place, it’s easy to deprioritize budget creation or overlook defined spending limits.
To help you avoid those outcomes, let’s unravel the complexities of law firm budgeting. We’ll cover why they’re important and the challenges they can present. We’ll also review the process of creating a financial strategy, tips for tracking against projected spending, and the essential features of law firm budgeting tools.
Why Budgets Are Important for Law Firms
At a high level, your law firm’s budget details financial expectations for the business in terms of revenue and expenses. A budget shows projected revenues and expenses, which net to bottom-line profits. Revenues, expenses, and profits influence bank balances and the ability to repay firm debt.
At a more granular level, a budget provides the details you need to run the firm efficiently and profitably, including:
- Spending limits for operating costs and client-reimbursable expenses
- Revenue required to cover expenses and meet financial goals
- Net income expectations
- Expectations for net income as a percentage of revenue
Once you have a budget in place, you can monitor the differences between actual and expected performance. These differences can reveal the firm’s highest priority financial initiatives. For example, if the firm is repeatedly falling short of revenue expectations, you should conduct research to understand why. You might find a disappointing collection rate or ineffective law firm advertising. Either issue would demand a quick resolution.
Challenges when Creating Law Firm Budgets
There are some common challenges associated with creating law firm budgets. Your firm may have unpredictable revenue patterns, inaccurate historical data, and unclear revenue goals. High-dollar technology investments and reimbursable client expenses can also confuse the budgeting process. Let’s review each of these challenges in more detail.
Unpredictable Revenue and Cash Flow
Revenue can be hard to forecast, particularly for younger firms with minimal history. You might start with an educated guess as to how many new cases you’ll secure each month. You can translate that estimate into a revenue prediction by defining the types of cases you’ll secure and how much you’ll charge.
The revenue associated with new cases is your growth expectation. If you have existing clients producing revenue, you’ll also estimate those collections and add them to the growth expectation.
Also, remember to consider revenue timing in your estimates. Even if your firm bills on retainer, the earned revenue is recorded after services are provided.
This process gets easier over time as the firm matures and establishes revenue patterns.
Inaccurate Historical Data
If the firm has not been disciplined about tracking financial data, you may lack the information required to predict revenue and expenses confidently. In this scenario, start tracking the financials immediately and fill in the gaps in your budget as best you can. Compare the firm’s actual performance to the budget often, adjusting as needed.
Unclear Revenue Goals
You may not have clear revenue goals for your firm, especially if you’re just starting out. This common issue may have you wondering: What constitutes good revenue for a law firm?
Comparable financial benchmarks can provide an answer. Two benchmarks to know are revenue per lawyer and revenue per employee. Revenue per lawyer among top firms ranges from $500,000 to $1 million or more, according to The American Lawyer. A reasonable starting target for revenue per employee is $150,000 to $175,000.
New Technology Investments
High-dollar technology investments can disrupt budgets before and after the money is spent. If the firm has already made the purchase, make sure the expense isn’t recurring in future spending estimates. If the purchase is planned, consider whether covering the cost in cash is realistic. Financing the purchase costs more, but it can be easier on the firm’s cash flow.
Keeping Track of Reimbursable Client Expenses
Reimbursable client expenses consume cash temporarily, so you should include them in the firm’s budget. Historical data by case type can help you estimate these expenses going forward.
If you do not have a system to track these expenses, make it a priority to implement one, as this is one of the biggest sources of profit leakage. Consider spend management software or law firm budgeting software that prompts employees to log and categorize reimbursable expenses and upload receipts.
How to Create a Law Firm Budget
Now that you’re familiar with the common challenges of budgeting, let’s define the process in steps.
1. Evaluate the Current Financial Situation
Begin by documenting 12 months of the firm’s expenses and their expected timing. Remember to include debt repayments and a line item for surprise expenses. This line should add 5% to 10% to the expense total.
Be sure to note the firm’s cash on hand and available credit. These figures become important when revenue timing doesn’t align with expense due dates.
2. Define Short-Term and Long-Term Objectives
Next, identify the firm’s high-priority, short-term and long-term objectives. These can involve growing the client base, increasing revenue from existing clients, paying down debt, etc.
Consider the investments needed to achieve these objectives. For instance, you might need to launch new marketing or referral campaigns or hire new employees. If needed, adjust your expense projections to include funding for these goals.
3. Project Revenue
Your revenue projections should flow from the firm’s current performance along with any new assumptions made in the first two steps above. A larger marketing investment, for example, should contribute to revenue growth.
If your firm has no history, make a conservative estimate using revenue per lawyer or revenue per employee benchmarks.
4. Estimate Profits and Adjust
Once you have revenue and expense projections, you can estimate monthly profitability and its effect on your firm’s cash flow. If the numbers do not add up to positive cash flow on the first pass, adjust them. Your budget may require more aggressive revenue goals or more conservative spending, and it’s better to know this upfront so you can plan for those outcomes.
Keep reworking the numbers until you land on a budget that meets your profit goals. The resulting revenue projections become your targets, while the expense predictions become your firm’s spending limits.
Law Firm Budget Example
You’ll want to track your budgeted numbers against actual performance within a financial application. However, you may prefer to manually create your budget first and then move the figures into your law firm’s budget software after it’s finalized. In that case, the table below can help you organize and categorize revenue and expenses. You can copy this spreadsheet here.
Tips for Tracking Your Law Firm’s Budget
Legal practice budget management includes budget creation and tracking actual performance against the projected numbers. For the tracking piece, automation with law firm budget software will be essential because it isn’t practical to copy numbers manually into a spreadsheet to determine if the firm is on track financially.
Using a law firm budget tool is the simplest way to implement the four best practices for budget tracking, which are: monitoring key metrics, creating budget report dashboards, automating expense tracking, and eliminating paper receipts.
Regularly Monitor Key Metrics
Key metrics provide a quick gauge of the firm’s financial performance in critical areas. Revenue growth, collection rate, utilization rate, operating margins, and net promoter score or another service satisfaction metric are popular high-level metrics to track.
Create Budget Report Dashboards
An effective budget report dashboard displays actual performance compared to budgeted performance. Ideally, the dashboard will show actual performance for each line item alongside the calculated percentage difference from the budgeted figure. That way, you can easily see the firm’s financial strengths and weaknesses.
Automate Expense Tracking
Your budget report dashboard will not be accurate without a reliable expense tracking system. To avoid month-end cash flow surprises and revenue leakage, expenses must be logged and categorized as they happen. Consider setting this expectation with your team and using technology to support the effort. A spend management program that prompts employees to record and categorize expenses immediately provides the most financial transparency for law firms.
Eliminate Paper Receipts
Paper receipts get lost and smudged. A missing or damaged receipt for a client expense can affect the firm’s ability to obtain reimbursement. Lost receipts for operating expenses delay expense recording and undermine the accuracy of financial reports.
Minimize those issues with a system for digitizing receipts as the corresponding expenses are logged and categorized.
What to Look for in Law Firm Budget Tracking Software
Legal practice budget management can be a tedious task if you don’t have the right tools on hand. A robust law firm budget tracking application should, at a minimum, automate data collection and provide reporting that highlights important financial trends. Specific features to look for include:
- Ease of use: The software should be intuitive.
- Integration with existing software: The software must share data with your accounting software and legal billing software.
- Reimbursable and non-reimbursable expense tracking with receipt uploads: Integration with the firm’s payment card accounts allows for immediate expense tracking, which is the best way to control law firm costs. Team members should be able to categorize the expense and upload a receipt shortly after the transaction has been processed.
- Digital case file integration: Client-reimbursable expenses should ideally be recorded within case files.
- Standardized and customizable key metrics dashboards: Law firm budget tracking dashboards that display key metrics provide quick insights into financial performance. Standardized dashboards are helpful for fast implementation, but you will probably also want to define your own data visualizations.
- Standardized and customizable reports: High-level and detailed law firm financial reporting provides data needed to clarify issues and prioritize initiatives.
Final Considerations for Law Firm Budgeting
Budgeting defines your firm’s finances today and documents how you want the business to evolve. Unfortunately, the complexity of the budgeting process prevents many law firms from using budgets to take control of finances.
Technology can solve those complexities. An integrated spend management application streamlines law firm financial reporting and provides complete control over employee spending. MyCase Smart Spend is an example. This innovative solution combines payment cards with expense tracking, prompting employees to categorize their spending and upload receipts. The data flows seamlessly into MyCase client files, invoicing, and financial reporting.
To learn how Smart Spend can provide control over your firm’s finances, enhance profitability, and improve financial transparency, schedule a demo or sign up for a free trial now.
