Successful law firm owners we work with and interview on LawBusinessPodcast.com understand how all the different facets of the business interact and affect each other; they don’t manage their firm without careful planning and attention to detail. Because financial management is the glue that holds together all the parts of a lucrative firm, mastering it is vital.
Don’t let financial topics scare you! Start with these four easy concepts to get a deeper understanding of your business.
1 – Plan to Spend
Recently, a client came to us with a question about how to start planning ahead and preparing a budget in a situation where it seemed impossible to estimate the future sales of the firm. In these situations, we always recommend to start by looking at the break-even point; this provides an idea of what the firm’s bare minimum collection must be in order to keep the lights on.
You can easily calculate your firm’s break-even point by adding together all of your fixed costs. These are expenses for which you are liable regardless of your caseload and may include, but are not limited to, the following: office rent, utilities, insurance, licensing, professional and payroll costs.
Knowing your break-even point is an important first step in planning your finances; however, we mustn’t forget about your own cash needs. You are, after all, in business to make a profit.
2 – Plan to Make Profits
The fact is, you got into business for yourself in order to make a profit. A very important distinction you have to make is getting paid for doing the actual client work and in addition to it making a profit because you are the owner of the firm.
Profits represent the compensation received for all the headaches you encounter from running and managing the firm and its employees, and for taking the risk and initiative of starting your own business.
Small law firm owners often fail to include the profit factor when they set their prices, and only charge for their time to do the actual legal work. This can prevent small law firms from growing, as it prohibits them from hiring associates.
As a rule of thumb, you should set your fees high enough so that one-third covers your general office expenses, one-third goes toward the cost of doing the actual legal work – even if you are the one doing it – and the remaining third is the profit to you as a business owner.
3 – Anticipate and Prevent Bumps in the Road
Most small law firms will, at some point, experience temporary cash shortages. You can minimize and often prevent the negative effects of these shortages by projecting the timing of your cash collections and expenditures.
A cash flow projection is different from an income statement, as it is not about profitability, but about the timing of the cash collections and expense payments.
The cash flow projection will give you a timely warning prior to running out of cash, so that you have a chance to take action and correct the situation before it becomes dire. You may have the option of trying to collect your accounts receivable faster or, if possible, prioritizing your caseload and working on client matters that have a retainer balance or higher chance for faster payments. You may even be able to postpone expenses.
Work with your CPA, or outsourced CFO, to put together a cash flow projection that will give you timely, meaningful and actionable foresight.
4 – Use Credit, But Wisely
Having access to credit can also be an efficient way to solve temporary cash flow problems. Using credit cards and taking out business loans is a common way to fund startup expenses. Established firms can access credit lines that help avoid interruptions of business operations.
Credit can also be useful to take advantage of growth opportunities such as new marketing campaigns or investing in more efficient technology.
Be wise when using credit in your business and have a solid plan of how to repay it prior to accessing it. Pay attention to any promotional rate expirations and make sure you understand the payment terms.
These four concepts will help you get a deeper understanding of what makes your business tick. Understanding the true costs of operating your firm will enable you to set your prices high enough to cover your costs and also make a profit. Bumps in the road are unavoidable, but by being proactive, planning ahead, and using credit wisely you can achieve your goals.