This article was originally written for Attorney at Work in 2014. It has been re-written and updated for this blog post.
2021 is almost halfway through. Soon you’ll be sitting down to do your monthly reconciliation for June. You may be tempted to go through your usual steps and call it done. Instead, we recommend taking this opportunity to do a little analysis to check on your firm’s financial health for the year. Are you on track to meet your profit goals? What can you be doing better?
With half of the year in the books, now is the perfect time to find out! Set aside some time at the beginning of July to evaluate a few of your firm’s financial metrics and law firm profitability. This will help provide you with a better picture of what steps you need to take for your firm to meet its financial goals. If you need to adjust, it’s better to find out before you plow through the next six months of the year.
Get started with your analysis by going back to the beginning of the year. Before January even began, you had a plan. Your budget. If you aren’t consistently reviewing the budget compared to your monthly expenditures, begin building the habit for the second half of the year. Look at your expected revenues and expenditures shown on your budget for the 6-month mark and ask yourself the big question: are you profitable and making money yet?
If you haven’t made a budget yet, it’s not too late to build your financial road map for the rest of the year. This blog post can help you plan for the next six months with a budget and a system in place. We’ve even included a sample budget tracker to help you get started.
To help you answer the big question of profitability, let’s begin by breaking down your financial data and key metrics with a few questions designed to help you focus on the different elements of your business.
1) Are you paying yourself a monthly salary? There can be pressure for you, as a practice owner, to undercut yourself in favor of other firm expenses. When budgeting for your firm, make sure you’re including a reasonable monthly salary for yourself (i.e. it covers your personal expenses) including your payroll taxes and retirement for yourself. Don’t fall into the pattern of randomly taking money out of the business when it looks healthy enough to do so, this is not sustainable for your firm, for you, or for your family. It can also be a very slippery slope leading to co-mingling of funds and an eventual audit by the IRS.
2) Do you know your monthly “nut?” “Nut” is a term we used to refer to your firm’s regular monthly expenses. These expenses should include payroll (yourself included) and other regular overhead costs like rent, utilities, regular office supplies, etc. Each month your goal should be to surpass your nut in income. As a best, calculate a month’s nut the beginning of each month then place it in a prominent place to keep that goal at the top of mind for yourself and your team! Once you hit this number, everything else is pure profit for your family and your future retirement.
3) Does your budgeted income number take into account your firm’s actual collection realization rate? Your budget should show your projected monthly income. As you look back over the first six months of the year, have you been meeting that projected income? Keep your firm’s actual collection realization rate in mind. Unfortunately, just because your team has earned and billed for $5,000, does not mean your client will pay the $5,000. Your budget should take this into account. If it does not, now might be a good time to reevaluate your budgeted numbers for the remainder of the year.
Take a moment to calculate your firm’s collection realization rate by taking your actual income for the first six months and dividing it by your total amount invoiced for the first six months. If it seems a little low, don’t panic. Doing this check-up now, lets you know it’s time to make a few changes to your billing habits and tracking your accounts receivable. Set a goal with your team to increase your collection realization rate to 90% or at least commit to increasing this by a rate of 2% each month. An increase of 2% can yield additional money without doing more work.
4: Do you know where you stand for the year so far in terms of profit and loss? In other words, do you know how your actual numbers compare to what you budgeted for? Your profit and loss statement, also known as an income statement, is your go-to report for comparing your revenue/income to your expenses. Many times, it will compare on a month-to-month basis, i.e. April, May, June. You may have made progressively more each month, but that might not mean you’re on track for making a profit for the year compared to your projected budget. Taking the step further to evaluate what your actual numbers were versus what you thought each month would be when you made your budget may show a very different picture.
Remember, your income is based on a few things discussed above: billing and collections. Expenses are something that can surprise you if you are not tracking them monthly. Having the prepared budget you review each month is invaluable for tracking expenses. You may not think you are spending a lot of money until you see it in writing. Your projected budget can also help prompt you to prepare for future expenses or months of anticipated shortfall.
One way to do this is to make sure you are using your tools to the fullest extent by creating a budget and financial tracker spreadsheet. Have your accounting system is set up with a chart of accounts that clearly separates your expenses by categories that make sense for your business. These categories allow you to evaluate your expenses without having to individually sift through each one. Put your budgeted amount in for each month as a benchmark. Every month enter the actual amounts spent compared to your budgeted amount and watch for any unusual trends. If one month was higher than usual or what was expected, adjust for the remaining months so you don’t overspend for the quarter or year.
5) Do you generate and review a cash flow report each month? Your cash flow report is a great way to keep an eye on your firm’s actual checking account balance. When you are reconciling each month and updating your budget/financial tracking spreadsheet (mentioned in #4), you will be able to clearly see how much cash you are starting every month with. This gives you the data you need to make decisions about your business expenditures so you can be proactive rather than reactive.
In the sample budget tracker/financial spreadsheet, the beginning cash balance for the next month is calculated this way:
Make a commitment to reconciling your bank accounts within the first few days of each month and updating your budget/financial tracker spreadsheet with the reconciled amount. Having correct and current data is essential for making good business decisions.
6) Do you know your average hourly rate? Take a moment to consider how many hours and dollars are you billing each month. Billing is a key component of your firm’s monthly activities. Knowing how much you are billing each month and what the trends are will help you more accurately project your firm’s financial success. Give yourself the information you need by consistently tracking your billable hours and bill promptly and regularly.
7) How many new matters/cases are you setting up each month? This question helps you evaluate your throughput. How many new clients are coming into your pipeline? Do you see any trends? Do you have an even balance of hourly vs. flat fee vs. contingent? By tracking the number of new matters per month, you can clearly see your firm’s level of growth and project trends for income. If a given month has a low number of new matters, that can mean that you may have less income in the pipeline for the months ahead.
8) Do you know what your outstanding accounts receivable at 30, 60, 90, and over 90 days are? As we mentioned above, accounts receivable represent an opportunity for additional profit for your firm by ensuring that you get paid for work your team has already done. By simply tightening up or putting in place good receivable management practices you set clear expectations with your clients early on regarding payment of invoices and enable yourself to increase your collection realization rate on those receivables. You are a small business owner and cash flow is important. Clients should understand and respect your business needs. If they don’t, fire them.
Set a goal for your team to implement monthly billing procedures and collect all payments before they hit 90 days past due. Start by creating a series of form letters requesting payments once the account hits 60 days past due and then follow-up regularly. Multiple studies show that accounts past due more than 12 months have a very very small chance of ever being collected. Don’t count on this money coming in. Write it off and move on.
If you don’t have a budget or a method to track your firm’s financial data, use July to get started! Build yourself a nice spreadsheet based on last year’s actual numbers. Compare to this year’s January-June and adjust as needed so you are ready for the second half of the year. This is an invaluable exercise and once done, it easily converts to an annual worksheet.
Improving your understanding of your firm’s financial metrics will help you layout strong strategic business development initiatives and a solid business plan for the year. Having a budget and a plan is critical to remaining competitive and profitable as a solo and small firm attorney.
Written by Peggy Gruenke with CPN-Legal, a company whose mission is to help solo and small-firm lawyers build better businesses. She is active in the ABA GPSolo Division and a frequent speaker at bar associations and ABA TechShow.