Running any business—including a law firm—starts with creating a documented long-term financial strategy and profitability model that aligns with your short-term budgets and reports, as well as with your long-term goals. These things are critical to managing your law firm finances the right way. While few law schools teach students how to run a business, knowing how to run a business is critical to running a successful law firm.
In this guide, we’ll help you understand law firm finance and how to plan for the future while staying on top of your daily budget. We’ll supply you with the tools and direction to develop solid financial best practices, and we’ll talk about financial strategy, budgeting, and bookkeeping.
We also have resources on credit card processing, taxes and accounting, and outsourcing your bookkeeping. And we’ll nerd out on financial reports, IOLTA accounts, funding your law firm, and time, invoices, and collecting.
Armed with the tools available to you and an understanding of the importance of using solid financial practices on a daily basis, you’ll be prepared to make your law firm a financial success.
To get started, here are a few best practices you should shoot for when it comes to your law firm’s finances:
- You have a documented long-term financial strategy and profitability model that aligns your short-term budgets and reports with your firm’s long-term goals.
- You have access to sufficient capital and cash-flows to fund your firm for the foreseeable future.
- You follow written budgets and regularly monitor consistent financial reports and financial key performance indicators.
- Your invoicing, payments, and collections systems are focused on your clients’ payment preferences so they will pay their bills on time.
- You pay yourself a consistent market-rate salary, separate from bonuses or distributions, and you are investing an appropriate amount towards savings and retirement.
Create a Long-Term Financial Strategy
As a business owner, you’ll need to stay on top of the numbers, forecast your budget, and manage your law firm’s cash flow on a daily basis. You’ll also need a vision for the future of your firm, your staff, and yourself. Do you envision a large, multi-lawyer firm that takes on huge cases and clients? Or do you see your firm as a stable solo practice that can comfortably support you and your family? If you have a vision for what your firm will be in the future, you will be more likely to end up there—and you will be much more likely to be happy when you do.
Get Access to Capital and Cash Flow Funding for Your Firm
Once you have a vision for what your firm will become and a plan for getting there, you will need access to sufficient capital and cash flow. You can finance a law firm with as little as a few thousand dollars, but more capital will give you more runway to make your business profitable.
There are many ways to obtain law firm funding and financing, including:
- Your personal savings. At least some of your financing should come from your own personal savings. That way, you’ll have some skin in the game. You’ll be more likely to keep working when things get tough because, well, you’ll have more to lose.
- Loans from friends and family. A loan from friends or family can come with the added benefit of an interest rate that’s below market rate. But, these loans can also come with strings attached and have the potential to create a strain on the relationship if they’re not paid back in time. Since each relationship is different, it’s important to weigh your comfort level before accepting a loan.
- Low-rate credit cards. Having a credit card with a low interest rate can be a great help in the early days of your practice when you need to finance operations before your firm generates enough revenue. It’s important to note, however, that this strategy requires great credit and access to interest rates that are truly low. Otherwise, the debt could prevent your firm from growing and becoming profitable.
- Bank loans. Bank loans offer lower interest rates than credit cards, but you’ll need to jump through more hoops to get them.
- Startup incubators and accelerators. Incubators can help new business owners by connecting them with the funding necessary to get going.
Budgets, Financial Reports, and Financial KPIs
Having a budget is critical to your law firm’s financial success. Without a budget, you won’t know how much money your law firm will spend in the next week, month, or year. In turn, you won’t know how much revenue is necessary to make your law firm profitable.
How to Get Started Creating a Law Firm Budget
At its most basic, your law firm budget is a list of expenses organized by category and broken down into digestible and relevant chunks. You will need to estimate your expenses and the revenue you expect to earn. Doing the math, you’ll have a solid idea of how much work you need to take in to make your business profitable.
To help you get started, we’ve created a budget spreadsheet that you can download. Use ours the way it is or let it inspire you to make your own.
Bookkeeping has a tendency to sound scary to lawyers, but it’s really easier than you think. Bookkeeping is a reliable system for keeping track of your law firm’s financial transactions. The key is to do it regularly. You need to be disciplined. Every time there is a transaction, write it down. Otherwise, you may form bad habits.
Over time, law firm bookkeeping that isn’t done regularly can snowball or become a mess that’s hard to untangle. When the mess involves IOLTA accounts, it can even lead to trouble with your law license.
But if bookkeeping is done well? It can be the single most powerful tool for giving you objective, actionable data about the financial health and well-being of your law firm. It might just be the most empowering habit you’ll ever develop for your business.
Law Firm Financial Statements
Generally, there are four basic financial reports in a complete, standard set of law firm financial statements. They are:
- Income Statement (or Profit & Loss Statement or P&L). This is the big one. It shows your firm’s total income minus your total expenses.
- Balance Sheet (or Statement of Financial Position). This one displays the “balance” of your firm’s assets and liabilities and all the owners’ equity in the business.
- Statement of Cash Flows. This statement tells you where your cash comes from and where it goes, and it groups those inflows and outflows into useful line items.
- Statement of Retained Earnings. This report helps you understand if you’re generating a cash surplus from your operating activities, investing activities and financing activities.
Each of these law firm financial statements can be a source of great insights about your business, although professional guidance is often best to help spot those insights, especially when you’re just starting out. For example, many lawyers consider their law firms to be profitable if they can pay all of the firm’s bills and the salaries of its lawyers. That’s not the only measure of profitability, however. When making your law firm profitable, you need a deeper understanding of your key performance indicators (KPIs), including how much time you’re spending on each case and how that compares to the income the case generates.
When you perform a deeper analysis, you’ll get a better idea of your law firm’s finance picture. You may see that some cases are significantly more profitable than others. You may also see that some cases require you to put in significantly more time compared to the profit they generate, or that some of your lawyers or staff members work much more efficiently than others. These insights can help you make better decisions about which cases to take on and how to structure your firm’s work.
Best Practices in Invoicing, Payment, and Collection Systems
People may tell you many things about invoicing and payment, but it all comes down to this: Running a profitable law firm is significantly easier when your clients pay you. To have that happen, you need to follow some best practices in invoicing, payment, and collection systems, including:
- Track your time regularly, every time, at the same time you do the work. Otherwise, you may find yourself trying to recreate weeks or even months of billing, and you’re likely to forget about a great deal of hard work that you put in.
- Require retainer fees. These advance fees give you the peace of mind necessary to work hard and get results for your client, without the risk that the client won’t pay. Make retainers mandatory, and track how much of the retainer is spent in every case. When the retainer is spent, make sure the client replenishes the retainer before you continue work.
- Don’t work when you’re not getting paid. Many lawyers make the mistake of continuing to work when a client has stopped paying. Don’t bury your head in the case and forget to bill the client or let non-payment slide. It is much easier to prevent a massive unpaid bill from accruing than to successfully collect on it.
- Get flat fees up front. If you’re opting for flat-fee billing, don’t trust that the fee will come after the work is done. Get the fee up front before you put in time on the case.
- Set billing expectations. Your clients will be more likely to pay their bills if you meet them where they are. Be flexible with your client’s payment needs yet discuss billing agreements and your billing schedule upfront. Setting billing expectations allows clients to stay in control of their finances, too.
What Should You Pay Yourself and Your Staff?
First things first, don’t confuse yourself with your law firm. How much money your law firm takes in is not the same thing as how much money you take home. When running your own firm, you need to pay yourself a market-rate salary that depends on your responsibilities. For example, if you’re taking cases during the day and then handling marketing and budget balancing late into the night, your salary should reflect all that you do.
Paying yourself a salary regularly, like any other employee, makes your life stable. But it’s also a good business practice. It helps you clarify your role and keep accurate data for your accountant when preparing financial reports. It also helps you avoid extra IRS audits that often target business owners who just pay themselves in dividends. And it helps make sure that your business is sustainable.
As for your staff, your compensation system should be fair to existing lawyers and staff while allowing your firm to recruit the highest-quality new lawyers and staff members. You can find a lot of information about market-rate salaries in your area on websites like Glassdoor and LinkedIn.
When firms are not turning a profit, sometimes the key is cutting staff. Nobody ever wants to do this, but it can be the best way to keep your business on track, taking your firm’s long-term financial strategy into account.
How to Be in Control of Your Law Firm Finances and Future Security
To be truly in control of your firm’s future security, you need to plan for the unexpected. Having the right law firm insurance coverage is an important part of that. Some coverage is required, while others are optional. You’ll have many options, including:
- Malpractice insurance
- Business Owner’s Policy (BOP)
- Commercial umbrella insurance
- Computer and media coverage
- Accounts receivable general business insurance
- Valuable paper and records coverage
- Business auto
Ask other lawyers and business owners in your network about what is working for them, shop around, and then seek the help of a qualified insurance broker.
Taxes can also hit lawyers in unexpected ways. Many lawyers think things are tax deductible that are really not. Moreover, your tax liability may be higher than you anticipated, especially if you are just starting out and running a business for the first time. Working with an experienced CPA is a good idea so that you can plan for your tax liability in advance.
A successful law firm considers the numbers first, creating a solid financial plan for the future. What started with a vision should continue with sufficient cash flow, a budget, a detailed billing process, and a market-salary that reflects your hard work. As you move forward, you’ll begin to see new opportunities for growth such as new practice areas, team members, and services. Keep making strides forward, creating the profitable law firm you envisioned from the start.
Learn From the Pros: Become a Lawyerist Insider
It takes a lot of hard work, dedication, and industry know-how to stay on top of the numbers, forecast your budget, and manage your law firm’s cash flow. Yet all of this is necessary to grow into a successful business. Luckily, you don’t need to reinvent the wheel to make it happen. As a Lawyerist Insider, you’ll have access to practice tools, information, and the pros who can help your firm grow.