The idea of creating a budget may feel overwhelming, especially if you’ve already been in business for several years. However, most firms will find the initial time and effort required to create a proper budget is well worth the decision-making guidance it provides. Whether you decide to do it yourself or work with a financial professional, it is important to understand the basic process and required information to get started. Here is an overview of the five-step process of budget creation.
Budget Basics: Revenue, Expenses, Profit
A law firm budget is an essential part of your business strategy that estimates
- Revenue – Money received by the firm
- Expenses – Money spent by the firm
- Profit – Money left over (Revenue – Expenses)
In most businesses, revenue and expenses are normally broken down into various subcategories, often referred to by your accountant or bookkeeper as part of your “chart of accounts”. A law firm chart of accounts, such as the one offered to Firm Numbers clients, organizes revenue and expenses to help identify drivers of profitability and identify opportunities for growth.
Your budget should include the amount you expect to receive (revenue) and pay out (expenses) in each of these categories for each month of the year.
A Side Note for New Firms
Startup law firms may not yet use accounting software (Quickbooks, etc.) with a formal chart of accounts to organize revenue and expenses. If this is the case, we recommend making your own list of revenue and expense categories as it relates to your firm on a spreadsheet. The categories you create, no matter how informal, can provide a crucial framework for business decisions at any stage, regardless of profitability.
Step One – List Your Revenue and Expense Categories
Start your own budget by vertically listing all your revenue and expense categories in a spreadsheet. You can pull these from prior income statements (aka statements of profit and loss), the chart of accounts in your accounting software, or your own estimated list.
Next to the list of categories, horizontally list each month of the year in order to break down each category by month.
Step Two – Gather historical data and conduct research
For established firms with an accounting system and financial statements, the income statement from the prior year is usually the first place to start.
For those who do not have their financial information aggregated in one place, this process can be more challenging. Newer firms should compile bank, credit card, and other applicable financial statements to provide a record of prior year financial activity, an activity similar to collecting information for tax return preparation.
It is also recommended to look beyond your own numbers and research industry benchmarks and/or consult with an accounting professional. Firms may also seek feedback from their peers via online forums and industry networking.
Step Three – Estimate monthly revenue and other income sources
Estimations for future revenue and expenses are normally based on prior year numbers, benchmarking research, and goals and objectives of the firm. Types of revenue may include hourly earnings, flat fees, consultation, referral fees, and more. It is important to also estimate other sources of income that support your firm such as personal savings, credit cards, or bank loans. For new attorneys, these income sources will be a critical component to supporting business activities. Remember to be careful with your math and remain conservative.
Step Four – Estimate your monthly expenses
Your monthly expenses may occur regularly (fixed) or fluctuate each month depending on business activity and other factors (variable).
Items such as internet, fees, software, bank fees, mobile phone service, and website hosting are generally easy to predict. Take stock of everything you need to run your business and enter your fixed costs for each month. Keep in mind some of these costs may be due to increase in the coming year.
Variable Costs & One-Time Spending
Variable and one-time or infrequent costs fluctuate throughout the year making it more challenging to estimate each month. Examples include transportation, events, postage, marketing, taxes, CLE credit, etc. It is important to plan ahead and make sure there is cash set aside for anything you want or need to buy for your firm throughout the year.
The actual timing of these outflows is likely to differ from your monthly estimates, especially infrequent costs. It is more important to anticipate these costs at some point in the year and manage monthly cash flow to fund expenses when they arise.
Step Five – Add in Some Cushion
A more conservative budget will set realistic profit expectations and reduce the stress of missing your numbers. Slight modifications to your estimates can provide a needed cushion to tolerate unexpected events. To build this in, increase your expenses 5-10% and reduce revenue and income numbers by the same proportion.
Like any business strategy, budgeting is only as effective as your commitment to putting it into action. Accurate and consistent bookkeeping provides a solid foundation and dramatically reduces creation time. It is also critical to schedule regular times to revisit and revise your budget. A monthly budget variance report, comparing your actual versus budgeted numbers, is highly recommended tool to help adjust your numbers throughout the year. These and other law firm specific financial reports are a standard feature of Firm Numbers bookkeeping packages. For additional guidance, contact our accounting professionals or subscribe to our newsletter for ongoing tips and financial best practices.
ABOUT FIRM NUMBERS
Firm Numbers provides small business owners bookkeeping and financial reporting designed to help you make better management decisions. Firm Numbers offers flat-fee monthly service packages to address the pain points of law firms and professional service providers nationwide.
- Weekly bookkeeping to ensure timely delivery of your numbers
- Enhanced reporting to provide additional management insight
- Service teams lead by former law firm CFOs and Business Advisors
Our goal is to help you be the boss, not the bookkeeper. We pull you out of reactive decision-making based on emotion and provide the necessary tools to objectively run your business.