Are you a law firm CFO experiencing signs of procrastination, insomnia, and occasional loss of concentration? There is a technical name for this disorder, it’s:
The very sound of it
Suggests a bad prognosis
But have no fear, this is a
Common accounting work psychosis
If you are a CFO,
There’s a simple diagnosis
It’s a simple fear your
Budget numbers might be atrocious
apologies to Mary Poppins, CFO
If you suffer from SuperMicroCalculatingBudgetingNeurosis, there is good news: It is never too late to publish the Law Firm Budget.
A comprehensive law firm budget entails three distinct components:
- Revenue budget projected on an annual and monthly basis;
- Expense budget computed on a detailed level; and
- Cash flow budget.
Revenue Budget For Law Firms
In most law firms, the individual lawyers and other timekeepers are the revenue generators. Their annualized billable hours, rates, billing realization, and collection realization efforts produce the firm’s revenue. Since most firms use a modified cash basis of accounting, the revenue budget needs to analyze:
- How quickly and successfully the firm will be in billing and collecting the unbilled fees and fee accounts receivable carried over from the prior year;
- The billable hours and effective rates likely to be generated in the coming year; and
- How quickly the firm will invoice the coming year’s billable time value into invoices and then convert invoices into collections, taking into account realization discounts likely to occur in both the billing and collections efforts.
I typically break this process into three phases — estimating the billable hours and billable time value projections, then the fee billing and fee revenue projections.
The Billable Hours & Billable Time Value Projections.
This process involves a spreadsheet consisting of columns detailing annualized billable hours of the prior year and projecting billable hours of the coming year, and the effective hourly rate for those hours for last year’s timekeepers and continuing timekeepers and those expected to be added during the year. I generally present two alternative columns for the coming year’s annualized billable hours projections — one labeled “Reasonable Projection” and the other representing a “Reasonable Projection plus a 6% increase (“R.P.+6%”) — which represent an additional two billable hours per week for a lawyer working 1,800 billable hours annually. The Reasonable Projection and R.P +6% columns are then multiplied by the applicable projected hourly rate for each timekeeper to yield two potential billable time value projections.
Fee Billing & Fee Revenue Projections
Among the year-to-year statistics I track for my law firm clients are the relative mathematical relationship between their actual billable time value for prior years and each respective year’s fee billing total, as well as the relationship between total fee billing and total fee revenue for the year. Assume a typical growing transactional/commercial litigation firm with the annual statistics shown in Columns C, D, and E.
|2016 Actual||2017 Actual||2018 Actual||2019 Reasonable Projection||2019 R.P +6%|
|2=3/1||Effective hourly rate||$321.62||$323.82||$335.00||2=3/1||$345.00||$345.00|
|3||Billable Time Value||$7,484,054||$8,332,811||$9,397,752||3||$10,162,308||$10,772,046|
Over the last three years, this firm invoiced clients (i.e., fee billings for the year) an amount equal to 95.6%, 95.4%and 95.1% of its billable time value recorded during the year. Similarly, the firm collected (i.e., fee revenue) equal to 91.5%, 94.0% and 91.2% of the aggregate annual fee billing. Assuming a continuation of those historic trends, absent other factors, the law firm’s revenue budget adopted the following revenue goals:
- Billable hours: 30,000
- Billable time value: $10,350,000 ($345.00 effective hourly rate)
- Fee billing: $9,832,500 (95% inventory turn — billable time value into fee billing)
- Fee revenue: $9,242,500 (94% inventory turn — fee billing into fee revenue
Word to the Wise #1: If your firm is achieving its revenue budget number each year, you may not be setting the bar high enough. Remember, reach should exceed your grasp. If you have questions or would like to discuss your law firm's budget then feel free to contact 4L Law Services.
Note: This article is the first of a two-part blog series on the law firm budget process.