How To Prepare A Budget In A Small Law Firm Explained…

I trust these few tips flowing from my 25-plus years as a law firm management consultant will be of assistance both for the late starters in Australia (your 2013-2014 Budget should be all locked away by now), and for smaller law firm owners and managers generally.

Right up front here’s one critical decision you can make…

Budgeting for Expenses is almost always the easy bit...delegate it!

Budgeting for the other side ( I hesitate to say the "Dark Side') is far too often addressed in small law firms by looking at what has been achieved in the past year and adding some percentage to that…bolder in good times (although usually not nearly enough) and little or nothing in tougher times.

This approach lacks vision and any real strategic quality, and generally locks firms in to another year of relatively mediocre performance.

It’s a better approach to get a real handle on what your true productive capacity was and why you did or did not achieve it in the year concluding.

My experience is that most firms if they are honest will identify themselves as falling within these parameters:

Didn’t have enough work…

Didn’t ever get file velocity optimised and billing up to date…

Lost fee-producing staff, and for whatever reason didn’t replace them…

Had plenty of work to keep the team busy but far too often felt under pressure to keep fees below what was really needed…a fair fee for the value delivered…

Often the reasons for a shortfall between capacity and actual will be a combination of factors, but in most cases I find a shortage of work, and that isn’t just in tough times.

It comes about because most small legal firms don’t place enough emphasis on planned Marketing/Business Development.

This inevitably leads to the periodic or continuous absence of what I have always called “A healthy backlog” of client file work. It is therefore simply impossible for the current capacity of the fee-earners, that is being fully invested in by the firm, to be achieved, shaving huge slabs off the potential profit and undermining the whole financial security of the firm.

It is made a lot worse if the capacity of the fee-earners is not properly understood in the first place, so that even those perceived by management (and themselves) to have a healthy backlog of work really do not.

In that case the firm has a cultural and systemic inability to generate the sorts of profit margins that it is in fact capable of with it’s present structure and Expenses, and being achieved by similar firms who are getting it right.

To fix this big problem, split the day of each employee into KMSFirmTime and KMSClientTime, using common sense guidelines for what amount of FirmTime should be appropriate for the skill sets of the individual, and how you want them applied to your Business Plan.

You will in 99% of cases find that the actual quality contribution of FirmTime across desired categories such as Marketing, Supervision, CPD, Knowledge Management, IT, etc., is far less than you would have imagined.

Unless that can be fixed promptly to your complete satisfaction your best way forward is to reduce the "ask" in FirmTime from the individual, and require the individual to invest more of each day they are paid for in the Client legal work they have been trained for.

In a nutshell, by grossly over-estimating the need for FirmTime, by at least an hour in the average day, and by not organising to provide enough client file work, most small law firms ask for far too little from their fee-producing employees, and yet ironically seldom even achieve that lowered goal. The survey statistics are consistently very clear on this.

On the other hand, in firms with proper systems and cultures, much higher goals are pretty consistently achieved.

What is it that you are budgeting for in a small law firm?

Remember to be very clear what it is that you are budgeting in any process.

Is it New Production for the period? The creation of Raw Work In Progress.

Is it Billings for the Period…Rendered Fees Invoices?

Is it Cash Collected for the period?

Of course it should be all three!

A major failing in many small legal firms (both when budgeting and when assessing "performance") is in placing far too much focus on fees rendered or fees collected.

The underlying production to current capacity, to optimise future billings and cash, is actually infinitely more important.

New Production in each period is of course the key to what you can ultimately bill and collect over the long haul. So you must be planning that down to the level of individual within team, using individual WorkPlans™.

In almost all work there is a lag time between doing the work and billing it, and that varies greatly…think Domestic Property and Medical Negligence as examples where the time lag can differ by years! Retainer arrangements paid in advance are a nice exception!

So while we would want to budget New Production in Medical Negligence work, we can expect fees and cash to flow throughout this planning period from work largely done in earlier Financial Years…only the final stages will involve New Production from this planning period. Agreed, these final stages often involve a frenetic flurry of intense work!

On the flipside, work done now, even at capacity or above, will in the main be billed, and fees collected, hundreds of days down the track on average, and in many cases, especially with today’s staff turnover rate often increasing, well after the fee-earner initially involved has left the firm.

All these variables need to be built into your three budgets.

Another twist of course is whether your firm accounts on a Cash or Accruals basis. There are still plenty of firms on a Cash basis, so much more often bills are not finally prepared and entered to the firm’s systems until the cash is about to hit the tin, so to speak!

Budgeting for fees rendered and cash flow in long tail work is only able to be as good as your systems for estimating when matters that have been running for a long time are likely to be completed.

So the bottom line is… budget for New Production, for Fees Rendered, and for Cash Collected.

Throughout the year run a very good Cash Flow projection that as accurately as humanly possible reflects all the flows in and out, and graphs the projected cash position relative to the limits in your finance facilities, so you can see particular pressure points coming well ahead and take the necessary action.

When cash is particularly tight I recommend moving from a fortnightly or weekly Cash Flow down to a daily one…with details altered daily there’s not as much to do to keep it up to date as one might think!

By focussing your New Production budget on the true capacity of your people you are:

Forced to think more throughout the year about work availability and Marketing…and...

Much more likely to get Revenue returns in due course from the key area of your capacity that was previously producing little or nothing. 

This area of oft-untapped capacity I refer to as “The REAL Profit Zone”. It’s clearly the real potential profit powerhouse of every firm, and having it doing absolutely nothing, either because you haven’t recognised the capacity, or have done little about the Marketing to take advantage of it, is an appalling waste that no good manager should be prepared to continue to countenance. 

It represents hundreds of thousands of dollars a year per Principal in lost profit in most small firms (and in plenty of bigger ones too as I have seen first-hand!).