Week 3: Your Financial Game Plan
Money in and Money Out: The Financials
By Peggy Gruenke, owner of Legal Biz Success
Find her on Twitter @PeggyGruenke
Let’s set the stage with a very positive image: Law firm business models are very profitable models. According to a Fortune magazine article, in 2014, law firms ranked second as a profitable business model with an average profit margin on 17.8%. So, yes, you can make money running a solo law firm!
This section of your game plan is probably my favorite because you will see the most return on your investment in this section. For most solos, tracking your finances is probably the weakest link in your firm and creates an opportunity for seeing quick progress. We are going to work together to make this section the most fabulous tool you will have in your game plan.
We have templates for you to use so that this section is less cumbersome to get through. You will be amazed at the change in your mindset when you start seeing on paper the money side of your business.
We are providing tools and guides to create a financial plan that works. You’ll be proactive with your decisions in 2015 by taking the time to analyze your key numbers and see where you can improve.
One last note before we dive in. The information below can get overwhelming. Take it step by step. And truly, the best long-term solution for keeping a pulse on your financials is to have help from a professional. If you’re looking for help – Kahuna Accounting has a special offer to transform your setup for 2015 and can provide all the reports described below.
Ok, let’s get started.
The finances of your firm
This section consists of creating the following:
• Creating your Economics of a Law Firm spreadsheet: The expenses and revenue of the firm and how you get paid
• Understanding how to breakdown expenses – this will become your chart of accounts
• Create a budget
• Calculating billing rates and understanding the effect of realization rates on revenue- both billing and collection
• Create a budget worksheet
• Creating a cash flow worksheet keeping an eye on the bank accounts and your monthly “nut”
• Identifying key metrics to track and measure
• Setting up profit and loss (P&L) statements
• Looking at software you are using – or not using – to capture all of this data
Economics of Your Law Firm Spreadsheet Overview
Our first step is to create a financial worksheet capturing your 2014 actual expenses and revenue collected. We will use this spreadsheet – Economics of Your Law Firm – using worksheets A & B. This document will become your master spreadsheet for this section of the game plan.
It contains the following and follow these rules when entering data: YELLOW means do not enter data. These fields have formulas and they will automatically calculate. GREEN fields mean you need to supply the data.
Download the spreadsheet here to get started
• Worksheet A: Enter 2014 expenses, by month if possible, to get to an actual amount spent for each expense category in 2014.
This worksheet is setup to reflect the proper way to set up your chart of accounts for your firm. The chart of accounts is simply a way to categorize firm expenses. The expenses are broken into 3 categories:
o Client Advanced Costs: Expenses where you are incurring the cost for fees related to client cases that you will eventually be reimbursed for through proper billing.
o Sales and Marketing: These are expenses related to generating revenue for your firm and we like to keep these expenses separate from expenses related to administrative needs and expenses of the business.
o General and Administrative: These are expenses related to running your business.
You can modify this spreadsheet and add any categories you see missing. But you do not want to go crazy and have too many expense categories.
• Worksheet B: This is where you will capture your 2014 revenue collected, how much money you paid yourself, savings, 401K.
This spreadsheet is meant to be a working document to see how changing numbers related to the following, affects your revenue, profits and your income. This worksheet may make more sense when you use it for Worksheet D – 2015 Economics of a Law Firm.
• Worksheet C: Use this worksheet to create your 2015 budget for expenses.
The work you did in Worksheet A should have resulted in actual expense numbers for 2014. You will use these actual numbers to create a 2015 budget. Keep in mind any additional expenses you will incur in 2015 based on completing sections 1 and 2 of your game plan.
• Worksheet D: This worksheet is the most important one for setting the stage for 2015 and seeing the potential you have for making money.
You will look at and literally play around entering the following numbers:
o Total hours you plan on billing for 2015. If you do a fair amount of flat fee work, do you best to think about these cases in terms of hours. Or add a new section for Flat Fee cases – projected number, fee per case and total flat fee revenue from these cases in 2015.
o Your billing rate
o Your billing realization rate
o Your collection realization rate
• Worksheet E 2015 Cash Flow Worksheet
This worksheet combines your Budget for expenses and revenue. This worksheet becomes the most important one for 2015 since it tracks, by month, all expenses and revenue, compares it to your budget and matches your bank balance in your business account. You will update this worksheet every month based on reports from your accounting system.
• Worksheet F Key Metrics
This document aligns with your goals you set in your plan for growing your business in 2015. Some of the key metrics I selected to track:
o Number of new matters per month, by type of case
o Amount billed by month broken down by hours and types of cases
o Amount collected by month, by type of case
o Billing realization rates
o Collection realization rates
o Accounts receivable
While gathering your 2014 actual financial data and key metrics, let’s ask a few questions to get you in the mindset of looking at your firm as a business and preparing for a more successful 2015.
How would it feel to have full control/visibility over your financial dashboards?
Economics of Your Law Firm Spreadsheet: 10 Questions
1. Are you paying yourself a monthly salary and is it enough to cover your personal expenses?
Or are you randomly taking money out of the business when the bank account looks healthy enough to do so?
Goal: Build you salary into your budget along with payroll taxes. It is tempting to just randomly take out money but the tax implications for this habit will catch up with you the next year. This task also requires you to create a personal budget so you know how much salary you and your family need in order to pay the monthly bills and save for your kids college!
2. Do you know what you have to bill and collect every month to cover your firm’s monthly expenses, which includes your salary?
This is your monthly “nut” – the money you will need every month to pay fixed expenses. Knowing your “nut” assumes you know your monthly fixed expense.
Goal: Calculate your “monthly nut.” Put this number in a very visible place so you look at it every month as a reminder that once you hit this number, you are making profit for your family and your future retirement.
$13,000.00 Monthly Nut = Income required to break even monthly
3. Does your budgeted income number reflect your collection realization rate?
If you budget to bill 1500 hours/year at $200/hour, your budgeted revenue is $300,000. But it’s not a perfect world and this is not what will be collected. Knowing your collection realization rates will help you set a realistic revenue number to drive your budget.
Goal: Calculate your YTD 2014 collection realization rate. Shocked at how low it might be? A collection realization rate of 90% should be an attainable goal for you. If it seems daunting based on how low your current collection rate is, don’t worry. This is one area of your financial dashboard that you can improve upon by changing billing habits and tracking accounts receivable.
4. Do you know your year-to-date profit or loss?
How are your actual numbers compared to what you budgeted for? A profit and loss statement is sometimes referred to as an income statement. It is simply an accounting report comparing revenue/income to expenses, usually shown monthly compared to last month for the same time period.
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.
Goal: Make sure your accounting system is setup with a chart of accounts that segregates expenses by categories that you wish to track. Then every month enter the actual amounts spent and watch for any unusual trends. If one month was higher than usual, adjust for the remaining months so you don’t overspend.
5. Do you have a cash flow report that you can look at every month?
A cash flow report is simply a way for you to keep an eye on your actual checking account balance. If you are reconciling every month and updating your budget/financial tracker spreadsheet, then you will know how much you are starting with every month – with enough money in the checking account or not enough. Once again, it gives you data to make decisions about your business so you can be proactive and not reactive.
In the sample budget tracker/financial spreadsheet sample included, the beginning cash balance for the next month is calculated this way:
Beginning check register balance
+ Cash inflow (revenue/income)
– Cash outflow (expenses)
= Ending month’s check register balance (match to bank statement) and next month’s beginning check register balance
Commit 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. How many hours and dollars are you billing each month and what is your average hourly rate?
You can’t get paid unless you are billing every month. Knowing how much you are billing every month and what the trends are will help you see your financial future, not through rosy glasses but actual numbers.
Track your billable hours and bill promptly and regularly. Train your clients to expect to pay monthly for their legal services.
7. How many new matters are you setting up each month and what has been the trend?
Is the pipeline full for continued cash flow? Do you have an even balance of hourly vs. flat fee vs. contingent?
Track the number of new matters per month and visualize the growth. A month with a low number of new matters can signal less income in the coming months. Especially combined with a low beginning check register balance. Knowing this ahead of time can help you prepare. Maybe look at expenses closely over these upcoming months and defer expenses if possible.
8. What is your six-month collection realization rate?
Is this a weak spot and a reason for low revenue numbers? Your collection realization rate is the percentage of your billed fees that is actually collected. Pretty simple stuff. Collection realization rates are often overstated because lawyers tend to leave uncollectible receivables in the system for an unrealistic time period, rather than admit the money will never be collected.
Commit to calculating your six-month collection realization rate and for the remainder of the year, set a goal to increase this by 2%. An increase of 2% can yield additional money without doing more work.
9. What are your outstanding accounts receivable 30, 60, 90 and over 90 days?
This is an area that can yield additional profit for your firm, without putting in longer hours, by simply tighten up or putting in place good receivable management practices. You are not in the business to extend credit and make loans. Set expectations with your clients’ early on regarding payment of invoices. You are a small business owner and cash flow is important. They should understand and respect your business needs. If they don’t, fire them.
Implement monthly billing procedures and collect all payments before they hit 90 days past due. Create a procedure to send letters requesting payments once account hits 60 days past due and then follow-up regularly. Analysis past due accounts in excess of 1 year. They have little chance of being collected. So don’t count on this money coming in. Write if off and move on.
10. Don’t have a budget or method to track your firm’s financial data?
Use the month of July to build yourself a nice spreadsheet so you are ready for the next six months in 2014. This is an invaluable exercise and once done, it easily converts to an annual worksheet.
Improved understanding of these financial metrics will assist you greatly with strategic business development initiatives–all of which are critical to remaining competitive and profitable as a solo and small firm attorney.
This is week 3 in our 4 week course. Next week, we’ll have some fun and dive into some marketing strategies to help you grow your business!
If you need to go back and catch up on our previous lessons, you can find them here:
For more reading on accounting fundamentals, check out these articles:
And of course, if you need help with your bookkeeping, Kahuna Accounting has a team of professionals who can make it easy. Sign up here for a 2015 fresh start!
See you next week!