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How to create a budget for your law firm

While many attorneys cringe at the thought of creating a budget, there are five important reasons why your law firm needs one, says Elizabeth Miller, an independent law firm administrator and consultant.

  1. Budgets help law firms achieve long-term goals, such as growing their businesses or buying an office instead of renting office space.
  1. You can’t spend money you don’t have: Preparing a budget and sticking with it will keep you from making unnecessary or frivolous purchases, because there is no money for them. Also, until clients have actually paid you, you don’t have that money. You should never use a credit line or credit card to make purchases you haven’t budgeted for, or to meet operating expenses.
  1. A budget helps your law firm prepare for unexpected expenses, such as replacing broken-down computers or copiers. Miller suggests budgeting $1,000 per month to cover such expenses.
  1. A budget will show you where your firm is bleeding money. Ten dollars here and $100 there can add up at the end of the month and potentially bleed your firm’s revenues dry. You will realize this when you look at your actual monthly expenses and compare that number to what you’ve budgeted for.
  1. You will be able to sleep at night and your employees won’t worry whether or not they will be paid. Don’t fool yourself into believing that your employees don’t know when your firm’s cash flow is in crisis. Valued workers who wonder about the survival of your firm may leave to seek more stable alternatives.

Where do I begin?

“Take a pen and paper, take your computer, sit down and take a look at what your expenses have been. A good way to do that is to take the expenses that the firm has paid out in the year before—everything that you’ve spent money on, fixed expenses only. That’s where you need to start,” she says.

Fixed expenses include rent, mortgage payments, payroll, telephone, insurances and vendors that you pay every month.

Now, divide those fixed overhead expenses from the previous year by 12.

“Set up a 12-month, month-by-month spreadsheet. Everyone does these differently. I use (Microsoft) Excel because it’s easy,” says Miller. “Itemize out one month’s fixed expenses for the month of January, listing each fixed expense and the amount. Duplicate that for 12 months. Each month should have the same monthly fixed total at this point.”

Then add to each month that month’s expenses that are not payable each month, such as auto insurance, malpractice insurance, or bar association dues.

“Any expenses which are payable only once or twice a year need to be added to the budget in the months that they are payable,” she says.

Miller strongly advises against financing expenses such as malpractice insurance because the costs of borrowing can really add up.

Here is an example of a 2019 budget created by Miller.

Why do most budgets fail?

“The number one reason that most budgets fail is because firms don’t accurately keep track of what their expenses are going to be. Don’t just do the budget—make sure that the attorneys stick to it,” says Miller.

No budget is going to be perfect, or for that matter, accurate throughout the year.

“In fact, the budget is really only accurate the day it is written. However, budgeting for unforeseen circumstances will reduce the stress when there is an unexpected firm expense and you have the funds (set aside) to pay for it.”

What if the law firm is new?

If your law firm has just started operating and you don’t have a prior year or month to use as a starting point, your attorneys’ revenue expectations may be far too high or far too low, according to Miller.

“The best time to start working with a budget if you are newly in practice is before you open your firm. New law firms need (to have banked) at least 90 days of income and operating expenses, and preferably 180 days’ (worth) until the firm can determine its operating position,” she says.

According to Miller, new firms need to keep their overhead low, outsource services, work from home, and take advantage of free or low-cost client development and marketing strategies.

“Track all of your expenses every single month. Know where every penny is going.”

Miller says it’s vital for new law firms to track the income they are generating as well, to ensure they are not spending more money than they are taking in.

“After six months and then after a year you should be able to track your income and expenses and begin planning an annual budget for your new firm.”

Establish a financial safety net

Your firm should be generating revenues that exceed its monthly expenses, so Miller recommends opening a money market account and making regular transfers from your operating account to the money market account. “Law firms have rainy days just like everyone else. Always be prepared.”

The bottom line

“Law firms are not exempt from the rise and fall of the economy. The profit margin and income of law firms have been affected in recent years and have necessitated a cutback in excessive or unnecessary spending,” she notes.

That reality has required law firms to more closely track their income and keep a careful eye on expenses.

“If you take the time or have someone managing the expenses of your firm, it will have a positive effect on the profits of your firm and contribute to the survival of your law firm, regardless of the economy,” she says. “When money is just taken out of the account and spent rampantly, there’s no control and there’s never any guarantee.”

While law firms that do not engage in budgeting won’t necessarily fail, Miller says the managers likely “sweat it a lot at night” and then start borrowing money to stay afloat. “It becomes a never-ending cycle.”

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