In part I of this series, we discussed the first two pillars of year-end financial planning for law firms: reviewing the current year’s performance and projecting the next year’s revenue. In this article, we discuss the remaining two.
Pillar #3 – Goal Setting and Budgeting Based On Revenue Projections
After a firm’s leaders have created or revised projection models to estimate the revenue their matters will generate in the coming year and when their firm will receive that revenue, they can begin setting financial and performance goals for that year.
A common starting point is identifying a profit amount or profit margin the firm wants to achieve. Once a firm’s leaders do so, they can work backward and establish a ceiling for their expenses based on their target profit/profit margin and projected revenue.
When establishing a ceiling for expenses, firm leaders should look at their expected fixed expenses first, like rent and payroll, since those expenses are likely to have the least amount of wiggle room. From there, they can determine how much money is likely to be available for discretionary expenses, such as investments in marketing and upgrading technology and infrastructure. Firms can do this as a percentage of budget or as a percent of revenue.
After a firm’s leaders determine how much money they will allocate to discretionary expenses, they can allocate those funds to specific line items. For example, if a firm decides it wants to spend $500,000 on marketing in the next fiscal year, firm leaders can divide that budget over various channels and tactics, such as television, billboards, and online. They can take similar approaches with expenses like technology.
Firm leaders can go one step further and determine the budgets for various marketing channels and tactics they will provide to particular partners or practice groups. Once leaders make annual allocations, similar to revenue, their firm must determine when to incur such an expense, assuming there’s flexibility in doing so. Regarding paying those expenses, firm leaders should consider their revenue expectations to prevent an expense from causing cash flow issues. By getting this granular with budgeting, firms can avoid expenses slipping through the cracks and putting dents in their profit margins. Also, this level of granularity helps with cash flow planning.
For any expense, firm leaders should project what return they expect to receive from it. Based on historical data, a firm might project a return of three dollars for every one dollar invested in marketing, or a profit margin increase of a certain percent when hiring a new attorney and giving them a full caseload.
Sometimes, a return on investment might not directly follow from the investment, but that doesn’t make it any less tangible. For example, an investment in new software that makes paralegals 35 percent more efficient could, over time, pay for the annual cost of the software ten times over each year. A new phone system leading to happier clients could pay for itself through increased referrals and online reviews that lead to more new clients being referred in by former clients.
With certain discretionary expenses or investments firm leaders should think long-term and beyond the coming year. For this reason, they should not be scared off by occasions to opportunistically exceed their budgets when testing new marketing campaigns, new technology, or new services. The consequence of doing so is simply less profit. The benefits of doing so are numerous, including more profit. On a related point, firm leaders should take a nimble approach to budgeting, giving themselves license to spend more money in one category (e.g., marketing) by taking savings from another category (e.g., travel), or by taking higher-than-expected revenue or a lower-than-expected expense and allocating it to an expense line instead of retaining it as additional profit.
Pillar #4: Ongoing Reporting
Just like trials aren’t won simply by what happens inside a courtroom, financial planning at law firms isn’t won simply by conquering a onetime planning process at the end of a fiscal year.
Ongoing reporting of key metrics to law firm leaders throughout the year helps a firm stay on track with its financial plans and can provide early warning signs that certain trends or events may upend a firm’s assumptions, planning models, or projections. Plus, this reporting over time can pinpoint flaws with, or blind spots in, a firm’s assumptions, planning models, or projections that will need to be remedied during the next round of year-end planning.
Each month, shareholders and the executive team at our firm receive a detailed monthly report regarding the firm’s finances. When we say detailed, we mean detailed: The report regularly tops out at over 100 pages. But the report is not just a collection of tables and graphs. Each report contains a simple but detailed narrative that educates the reader about the story the report’s data is telling. And while our monthly reporting is lengthy and granular, it is not necessary for reports to be so. The key for law firm leaders is to find a level of reporting at their firm that allows them to unlock and understand what the numbers are saying for that reporting period.
Our monthly reports are important because they keep our firm’s leadership apprised of how actual revenue, expenses, profits, and budgeting compares to our projections for those items. We can easily see whether there are anomalies that are causing our projections and budgets to be off-target, and whether our marketing efforts are driving revenue we projected they would in the manner we projected they would.
To keep these ongoing reports effective, the people at a firm tasked with creating them must avoid drowning shareholders and management in data. These individuals need to know what is important to their firm’s leaders, what data points most interest them, and how to translate and summarize what the numbers are saying. Firms that issue these ongoing reports will need to build their finance and accounting teams in a way that allows them to balance the flurry of activity each month related to these reports with the day-to-day finance and accounting work they normally handle.
The First Four of Many Pillars?
The ins and outs of law firm financial planning are complex and variable. A strategic and effective planning process for a twenty-attorney catastrophic injury plaintiffs’ firm may be neither strategic nor effective for a twenty-attorney insurance defense firm or a 200-attorney insurance defense firm.
However, all law firms would benefit from year-end financial planning that rests upon the four pillars we described in parts I and II of this series. There will undoubtedly be additional pillars firms with certain practices, or that are of certain sizes, would benefit from by incorporating into their own planning. But these four pillars provide a solid financial foundation any firm’s leaders can build their year-end financial planning on, ensuring their firms remain going concerns that can serve their clients and society.
If you have questions about the four pillars we discussed in this series or year-end financial planning at your firm generally, please email us. We’d be happy to talk you through the process.
Shawn Lehocky is the chief executive officer of Pond Lehocky Giordano LLP, the largest workers’ compensation and disability law firm in Pennsylvania, and one of the largest in the U.S. Bryan Reilly is the firm’s chief financial officer. They can be reached at slehocky@pondlehocky.com and breilly@pondlehocky.com, respectively.
Reprinted with permission from the December 12, 2023 edition of The Legal Intelligencer © 2023 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.
