We’ve got to talk about your law firm budget. Specifically, we’ve got to talk about how much money you’re planning to spend and how much of it you’re expecting to earn.
Love it or hate it, budgeting is how you find your foundation as you start a law firm and how you keep your footing as you grow.
What Is a Law Firm Budget?
At its most basic, your budget is a list of expenses organized by category and broken down into digestible and relevant chunks. For example, if you are starting a law firm, you need a budget separated into at least three phases: startup, monthly, and annual budgets. Having sound estimates about what you’ll spend in a given week, month, quarter, or year is critical. Likewise, you need to know what revenue to expect in a given period.
On a much deeper level, your budget is strategy in the raw. If you can distill your core values and strategic direction into cells on a spreadsheet, you have the makings of a powerful and objective tool to means-test your vision.
Why Develop Mastery for Your Law Firm Budget?
Taken together, your expected revenue and your anticipated expenses tell you how hard you’ll need to hustle, whether you’re on track, and how to shift strategy as revenues and expenses ebb and flow.
When it comes to starting a law firm, effective and reasonably-accurate budget forecasting lets you project how much money you need to get started and how much you will need to generate on a recurring basis to pay yourself a competitive wage and invest in your firm’s long-term success and sustainability.
For firms looking to grow or invest in technology, people, marketing, or other strategic improvements, effective budgeting helps you build your strategy and launch it into action.
There are other reasons, too. For example, effective budgeting lets you:
- Spot problems before they morph into emergencies.
- See a snapshot of how your law firm is performing year to year and month to month.
- Increase your odds of securing a loan, since bankers and lenders want to see your budget before they offer you debt financing in the form of a line of credit, credit card, or traditional bank loan.
- Share your business with your employees to get their buy-in and align their incentives.
- Manage and minimize risk.
Running your law firm without a budget is like driving your car in a new town without a GPS-powered mapping application and real-time traffic data. Sure, you can do it. You might even think you know where you’re going and the best way to get there. But often you have no earthly idea.
Budgeting Basics: Your First (or Next) Law Firm Budget
Undoubtedly, there are kernels of truth in the old cliché that you need to “spend money to make money.” It is also true that spending money is no guarantee that you’ll make a dime.
In the early going, then, you should invest only in tools and efforts that support you in finding your first paying client, delivering them an 11-star client experience, getting paid for your work, and leveraging that early success to find your second paying client.
If you’re starting a law firm, you need to put together two spreadsheets: your startup budget (with sources and uses) and an ongoing budget (with income and expenses), broken down by month.
Your startup budget for launching a new law firm needs you to decide what you need to acquire (the “uses”) and what money you’ll use to get it (the “sources”). This can be difficult because your sources are almost non-existent and your uses almost infinite. Be strategic, and know that every dollar you spend will come from your personal savings or some form of debt (either through your friends and family or, if you’re really lucky, a bank or credit union). You’ve got to spend it, but you’re wise to do it awfully carefully.
11 Practical Steps for Drafting Your Law Firm Budget
Everyone does budgeting a bit differently, and as your business evolves, so will your budgeting process. But for starters, you can follow these eleven steps to launch your first budget.
1. Research Industry Standards
You need to understand law firm finance fundamentals. Resources abound for things you will include in your law firm budget. A targeted research session will yield great ideas for how to price your services, what fixed and variable expenses you should anticipate from the get-go (and which ones you’ll want to wait on and grow into), and what unexpected variables you might see in your first year. As you might expect, Lawyerist is a reasonable place to get an idea of how much it might cost to start a solo law firm.
2. Make (or Download) a Spreadsheet
Luckily, we’ve also got you covered here. We’ve put together a draft budget with conditional formatting that will let you know how much you’ve spent and whether you’re on track or off. Your mileage may vary, of course. Customize it to your needs, sources, uses, and expectations, and let us know how you tweaked it so we can update it to make it better for everyone else.
Download our Starting a Law Firm Budget Template.
How many clients do you think you’ll earn? How many matters will you open for each of them? How much will you charge them? And what is the average revenue you can expect from each matter? Obviously, this step involves some optimism, some pessimism, (or maybe some optimistic pessimism?), some simple math, and a leap of faith or two. We like starting at the end: how much profit do you absolutely need to make this inaugural year work? Then break it down. How much do you need to earn each quarter? From there, how much do you need to earn each month? To do that, how much do you need to earn each week? And to earn that much each week, how much will you make each day? Each hour?
4. Tally Your Income Sources
If you’re just starting a law firm, your startup “sources” have nothing to do with what you’re selling or how much of it you’re expecting to sell. It only concerns how you finance your launch before you start selling. This money comes from your personal savings, credit cards, loans from family or friends, or—if you’re fortunate enough to have the option—a more traditional bank loan.
Then, your ongoing budget will eschew those one-time startup funding levers and use sustainable ones instead. That is, how much money will you generate from hourly earnings, flat fees, subscription fees, initial consultations, referral fees, and other sources? Do some math. Be conservative at first.
5. Estimate Your Fixed Expenses
These are expenses that cost the same amount every month. Some common fixed expenses include rent, utilities, salaries (including at least a portion of your own), internet, fees, software and other subscriptions, bank fees, cell phone service, website hosting, accounting and bookkeeping services, legal services, insurance, legal research, and law practice management software. Tailor this list to your reality.
6. Plan For Your Variable Costs
These expenses don’t have a fixed price every month. Instead, they scale up or down depending on a variety of factors, including vagaries in advertising and promotion or your hiring outside contractors to help with a particularly challenging matter or project. Typical variable costs are contractor wages, advertising, other marketing costs, transportation, travel and events, printing services, postage, advanced client costs, interest, and taxes (among others). Don’t forget annual expenses that can sneak up on you, like malpractice insurance premiums, state bar licesnses, bar association dues, events, conferences, and other travel, and CLE credit. Again, pick the ones that are relevant to your practice and start projecting.
7. Predict One-Time Spending
This step is critical if you’re just starting a law firm. You’re going to have one-time expenses that add up quickly. The good news is that you won’t have to spend on these things again for a while, so you don’t need to include them on your long-term budget. The list includes hardware (computer, tablet, scanner, printer, backup drive, etc.), branding, website design, furniture, office supplies, letterhead and business cards, etc.
Again, tailor this list to the sources you’ve got available and trim it down (or scale it up) depending on your strategy and resources.
If you are an existing law firm building out your budget, this step applies to you, too. Next year’s budget should include a list of things you need or want to buy in the coming calendar year, including new hardware, software, website or brand redesign, systems, tools, consultants, and automation. You can always reinvest in your business, whether one-time dollars or ongoing expenses. The point is: be intentional about it.
8. Factor in Some Cushion
Now take every number on your expense side and add 5-10%. Then take every number on your revenue side and subtract 5-10%.
9. Figure out Your Gross Profit Margin
Here’s where you’ll pull it all together. First, though, a few definitions:
- Cost of Services Sold: This is the total cost you incur to deliver your services. It includes direct labor costs (salaries paid to lawyers and paralegals delivering the services), wages for part-time or freelance professionals delivering the services, and the costs directly related to delivering the services, like gas and travel tied to the specific matter, or sales commissions or bonuses paid to the professional who generated the work. Indirect costs include, for example, wages paid to support staff attributable to the particular matter.
- Operating expenses. Operating expenses are expenses your firm incurs in your normal business operations. These expenses are unavoidable and include rent, marketing, insurance, salaries and wages not tied to a specific matter, and other expenses not directly tied to the cost of selling a particular service.
- Profit margin: This is a measurement of profit expressed as a percentage that reflects the amount your firm earns for every dollar of sales. It takes all of your firm’s revenue and subtracts all of your expenses (operating expenses and cost of services sold). If your law firm generated $100,000 in revenue and you were able to keep $20,000 of that after paying all your expenses, you would have a 20% (net) profit margin.
- Gross profit margin: This particular profitability measure shows the percentage of revenue that exceeds the cost of services sold. In other words, it is how much money your firm has left over after you pay all the expenses that are specifically related to selling your services. For example, if your law firm charges $1,000 to register a new trademark on a client’s behalf, and if it costs you 700 dollars (in related labor costs plus other associated costs) from start to finish to work through that process, you have a 30% gross profit margin on your trademark services. If you don’t have enough gross profit, you don’t have enough money to pay for your operating expenses. And if you have particular services that are particularly profitable, you might think of ways to make them more prominent in your practice.
Things can get a little murky here. If you’re a true solo, a significant portion of your time is spent servicing, advising, and litigating for your clients. Those are direct labor costs and you should include them in your Cost of Services Sold and gross profit margin calculations. But you also do management, marketing, sales, and all of the other things. Those are operating expenses and you should not include them in your Cost of Services Sold.
Beginning to think about your revenue and expenses in these different ways will be particularly useful as your law business matures and you implement your strategic vision.
10. Take Time to Readjust
If you’re missing your budgeted numbers, you can reduce expenses, delay one-time purchases, increase sales through more aggressive marketing or advertising, or lower your profit expectations. When you know and monitor your budget, you can quickly see when you’re off target and cut costs or make strategic investments to increase revenue.
As your budget year crawls on, you can adjust numbers to more accurately reflect reality and plan the rest of the year accordingly. Trending significantly ahead? See what strategic opportunities you have for reinvestment and plug those into your budget. Once it is on the spreadsheet as a budgeted expense, you’re much more likely to actually spend it, rather than just waiting until the end of the year and paying yourself more just because there is some money lying around. If you’re trending behind, it is better to know sooner rather than later so you can react accordingly.
11. Think About It & Talk About It!
Finally, think about your law firm budget regularly, and talk about it transparently with anyone you trust and who will listen. This is absolutely true for any other partners in your business. But we would argue that it is also a great topic for discussion with your whole team.
We recommend a monthly reconciliation between your budget and your reality. Manipulate your budget spreadsheet to include columns for your actual monthly revenue and expenses and a place to show the delta between your budget versus your actual. If you’re missing your numbers, use conditional formatting to show those numbers in red to call your attention to them.
Whether you’re staring a law firm or just starting to take your existing firm’s finances more seriously, a law firm budget is a crucial piece of your planning. Spend time with these concepts and do careful work here. It will help develop a sound foundation for your entire enterprise.
If you’re uncomfortable with any of these concepts, it may be wise to invest in a consultant who will learn about your firm, make judgments about what you’re spending, see if you have alighed your spending with the rest of the market, determine whether you’re spending money on unused (or under-used) resources, and help you decide whether to do some strategic spending reprioritization.
A nascent law firm’s cash flow situation is likely to change. Sometimes quickly and dramatically. A client or matter won or lost could make or break a month, quarter, or an entire year.
That’s why our advice in lawyers in the early, fragile days of owning a law firm is similar to our advice as your law firm matures:
- Spend time in your budget.
- Be vigilant in finding efficiencies.
- Find ways to automate as many elements of your business as possible.
- Spend money on things that save you time so you can focus more time on more work that will get you paid.
- Invest in a robust and affordable practice management software, consider accounting software that helps you automate your bookkeeping, and implement a payment processor that lets you take credit cards.
- Spend time, energy, and money on finding your next clients and helping them choose to hire you. In other words, focus on marketing, sales, and exceptional client service.