A Guide to Law Firm Finance Management
You didn’t spend years studying to practice law to keep track of your firm’s legal accounting. But if you want to succeed, managing your firm’s finances ensures you get paid for your services, and more cash is coming in than going out.
Whether by setting a budget or reviewing your monthly profit and loss statements, leveraging a few financial tools can help you stay on track — and ensure you’re on the path to revenue growth. Read on to find out what law firm financial management entails and how you can easily set it up using legal software.
What Is Law Firm Finance Management?
Law firm finance management helps you keep track of your firm’s financial well-being. On the most basic level, you can start by setting a budget, then implement regular financial check-ins by running monthly and yearly reports. Next, set financial goals and use benchmarks to measure your firm’s success.
So, to manage your finances, think about:
Setting a budget: This helps you plan for your anticipated expenses and create a plan for covering them. Even a basic spreadsheet will do when setting up your first budget.
Setting short-term financial goals: Start by setting monthly goals for how much money you want to make.
Estimating yearly financial projections: Consider what you’ve made in past years or believe you could make based on reasonable market assumptions. Think about how many clients you’ll take on and what you could make from each account.
Updating and reviewing reports regularly: Your accounting department (if you have one) should be generating monthly reports, like profit/loss statements or cash flow reports, so that you can check in on your firm’s performance regularly. You should also regularly record your expenses and billable hours so these reports are current.
Of course, if all of this sounds like a recipe for a headache, remember that you don’t have to do it yourself. Legal technology can automate your financial management system so you don’t have to worry about pouring over the books. Practice management software can help you ensure you’re billing clients promptly, manage your trust accounts easily, and run custom reports at any time, among other capabilities.
Breakdown of Law Firm Financial Management
In some instances, these concepts may be familiar and your firm could be doing everything right to manage your law firm finances. However, there may be hidden bottlenecks that are hindering you from seeing the long-term growth you’d expect.
Let’s dive a little deeper into the pillars of law firm financial management: budgets, accounting, and financial planning.
Setting up your budget is a crucial foundation for all other aspects of your law firm’s finances. Your cash flow, revenue, and profitability all start with your budget. If you aren’t accounting for certain expenses, it’ll show up in your profitability.
However, one of the biggest mistakes law firms can make with their budgets is thinking they should spend as little as possible on business expenses. Maybe you want to limit your marketing or technology budget –– or spend nothing in those categories. However, be prepared for this to show up and affect your firm in other ways. You might bring in fewer cases or have a more challenging time managing invoices.
We heard you groan, but don’t let legal accounting bore you into neglecting it. Legal accounting is crucial to your financial management and can also bring serious trouble if you fail to tend to it according to state bar rules.
Ensure you have systems in place to:
Take payments from clients
Manage trust accounts and keep these separate from your law firm’s finances
Keep your personal finances separate from your firm’s
Maintain accurate records of expenses and payments
You can see why these aspects of legal accounting are crucial for your business — financially and legally. Keep tabs on your overhead costs, receipts for incidental expenses, and costs related to your cases.
Hiring an accountant can also make sense, especially if you have a solo practice and you’re starting to grow. Again, legal software can also make a big difference, helping you run more efficient and automated processes for legal billing and record keeping.
Growth Trajectory and Law Firm Planning
Within your law firm business plan, you should have an outline of your budget. Using this as your guide, you can start planning for growth.
So, let’s say that you anticipate that you’ll make $300,000 in one year, according to your budget. If you want to make $350,000 the following year, what will it take to make that extra $50,000? And let’s say you want to triple your income in ten years. You can start looking at the financial levers you can work with to reach those numbers, like your case volume, the value per case you take on, and more.
How to Create a Law Firm Finance Management Plan
Now that you’ve got the basics down, let’s talk more about how to create these financial management systems and make the most of them.
Create a Budget
Here’s what to include in your budget spreadsheet: all your estimated costs, both fixed and variable. Your fixed costs include anything that you expect to pay with certainties, such as lease payments or other overhead fees. Your variable costs might include fees related to your caseload, such as travel costs. Remember to include your projected revenue to determine if you’re on track to cover these expenses.
Also, you’ll want to include your expected revenue. Include both your estimated costs and revenue for the year.
Analyze Revenue, Profitability, and Cash Flow
Revenue and profitability are two separate things. Revenue is the money you make each month, and profitability measures how much you’re making based on your output. You can measure profitability by looking at the number of hours of services a lawyer offers and the number of those hours for which you can bill.
Several types of financial reports can help you analyze revenue and profitability. For instance, your profit/loss statements can show your actual expenses, revenue, and monthly net income. You can also look for trends by month, determining where your caseload lags and where your expenses, like payroll or travel costs, may spike.
Cash flow refers to another financial metric: the cash you have after paying your expenses. Importantly, it’s different from revenue because it refers to the actual money in the bank at any given time.
If you look at your monthly cash flow reports and find that you’re chronically struggling on the cash side, you may want to capture your client’s payments faster or reduce inefficiencies in your case timelines.
Set Realistic Goals and Expectations
Another key to law firm financial management is setting goals you can reach. So, in the previous example, we said that you might want to make $300,000 in one year and $350,000 in the next. That might be doable if you plan to bring in more cases.
But you can also think beyond revenue or salary-based goals to measure your firm’s success. Think of client satisfaction goals or other law firm marketing goals, like page conversions. Of course, just remember to keep these goals ambitious but achievable.
Types of Law Firm Finance Strategies
Your budget and financial management strategies are just that: strategies to help guide you toward where you want to be. A budget is not a promise that you’ll only spend X dollars, and a single month’s profit/loss statement is not the end-all, be-all financial statement determining your firm’s health.
The key to law firm financial strategies is to align them with your legal billing and growth goals. Keep in mind that businesses are constantly dealing with the unexpected. If you don’t meet your goals in one quarter because one important case took weeks or months longer than anticipated, remember that you could learn from that experience and bring in more revenue in the next quarter.
With these fluctuations in your firm’s business, it helps to create both short- and long-term goals. By breaking down your performance monthly or quarterly, you can fine-tune the elements of your finances over time to help meet your long-term goals.
And when you’re budgeting, remember to add cushion. You might expect your overhead or utilities to cost a certain amount, but chances are, they’ll be a bit more. The same goes for your revenue. About 5-10% is a good number to shoot for.
Measuring Your Law Firm Finance Management
Measuring your law firm’s financial performance sounds like a good idea, but how do you do that? As mentioned previously, revenue goals aren’t everything. You can explore dozens of key productivity indicators (KPIs) that could be useful for your firm.
Think about KPIs like increasing your billable hours or revenue earned per case. You can also consider your collection rate, which looks at paid versus unpaid accounts. Improving cash flow or increasing gross margins could also be good KPIs to measure.
Whatever goals you set, be sure to put benchmarks in place to review your performance throughout the year. Use financial reports to monitor your progress or opportunities consistently. If you want to reduce your accounts receivable, you can set quarterly goals based on the previous year’s performance.
If your firm only collected 25% of its accounts in the last year, you could set a goal to collect 26% in the first quarter of the new year until you reach 29% by the next December 31.
Outlook on Law Firm Finance Management
One of the easiest ways to ensure that you’re managing your law firm’s finances is to outsource some of the work involved. According to a Bloomberg survey, nearly eight out of ten law firms use legal billing technology.
Ensuring that your law firm’s books and invoices are in order is crucial to your practice’s shot at long-term success. With legal practice management software, you can easily track your billable hours, manage invoices, capture client payments, and create custom reports — all in one easy-to-use place.