Most growing law firms build next year’s budget by taking this year’s numbers and adding five percent. That is not a budget. It is a forecast of doing the same thing again.
Budgeting is the most common reason a managing partner calls me. And it is almost never just about the budget. By the time we finish building one, we have usually learned whether the books can be trusted, whether the partners agree on where the firm is going, and whether the firm is planning around what it bills or what it actually collects.
A good budget answers all three. Here is how to build one.
What is a law firm budget?
A law firm budget is a month-by-month plan for revenue, expenses, compensation, and cash, built from where the partners want the firm to go. It is the financial version of the firm’s direction. Once it is set, it becomes the yardstick the partners measure the firm against every month.
That last part matters. A budget that gets built in November and opened again the next November is not doing its job.
Why do most law firm budgets fail?
Not because the math is hard. Because of how they get built:
- They start from last year instead of from where the firm is headed
- They sit on top of books nobody fully trusts
- Revenue is built from hours, not from what actually gets collected
- Partner compensation gets figured out after the budget, instead of inside it
- Nobody reviews it against actual results until something goes wrong
How do you build a budget for your law firm?
Seven steps. The order matters.
1. Start with direction
Before anyone opens a spreadsheet, the partners need to agree on what next year is supposed to accomplish. Are you adding attorneys? A practice area? Moving away from a type of work that keeps everyone busy but does not pay? Every number in the budget flows from those answers. We wrote about this in The Difference Between Managing and Leading Your Law Firm: the numbers follow the direction. They cannot replace it.
2. Make sure the books can carry it
A budget is only as good as the numbers underneath it. Before you build, look at the last twelve months and ask:
- Are expenses recorded in the right categories, every month, on time?
- Can you see revenue by attorney and by practice area?
- Do you know your realization and collection rates, not just billable hours?
If the answer to any of these is no, fix that first. Budgeting on top of disorganized books just gives you a very confident wrong answer.
3. Build revenue from the bottom up, one timekeeper at a time
Top-down targets are easy to set and hard to hit. Build revenue the way it actually happens:
- Timekeepers x expected billable hours x rate = what the firm could bill
- x realization = what the firm actually bills after write-downs and discounts
- x collection rate = what actually reaches the bank
Forecast flat fee, contingency, and other alternative fee arrangements separately, since they do not follow the hours. Include the people you plan to hire, and give them a realistic ramp instead of a full year of production. For a deeper look at how revenue turns into profit, see our post on law firm profitability models.
4. Build expenses in four buckets
- Fixed: salaries, rent, malpractice premiums, bar dues, and the technology the firm runs on
- Variable: bonuses, benefits, travel, marketing, and anything that moves with volume
- One-time: a new office buildout, a system change, a major hire’s recruiting cost
- Reserve: money set aside for what you did not plan for, because something always comes up
Put every recurring cost on one list and flag the renewals. When in doubt, estimate high. Nobody has ever been upset that expenses came in under budget.
5. Plan for timing, not just totals
An annual budget divided by twelve will mislead you. Law firms have seasons: year-end collection pushes, slow January and February cash, big matters that bill for months and then stop, tax payments, and partner distributions that come out on a schedule whether the cash is there or not. Build the budget month by month so the partners can see the tight months before they arrive.
6. Put compensation inside the budget
Partner draws, distributions, and bonuses are usually the largest number in a law firm’s plan. When they get decided after the budget is done, the budget stops meaning anything. Build them in, and agree up front on what happens to compensation if the firm lands above or below plan.
7. Agree on it, then put it on the calendar
The partners should sign off on the budget together, and then see it again every month. Set the date the monthly numbers will be ready, and hold to it.
What should partners see every month once the budget is set?
Keep it short enough that the partners actually read it:
- Revenue billed and collected, against budget
- Cash position, and what the next 60 to 90 days look like
- Work in progress and accounts receivable, by age
- Expenses against budget, with anything off by a meaningful amount explained
One thing from the finance side: the most common gap I see is between billing and collections. Firms budget what they bill and then live on what they collect. If the budget does not show both, the partners will be surprised every quarter, and it will not be because the market changed.
When should a law firm start next year’s budget?
In the fall, while there is still time to act on what you find. Starting in September or October gives the partners room to settle direction, clean up the numbers, and approve the plan before January. A budget finished in February is already behind.
Where 3sixty fits
Building and running the budget is a core part of what a fractional CFO does for a growing firm: setting it up with the partners, tying it to compensation and hiring plans, and reporting against it every month so the partners can spend their time leading the firm instead of chasing the numbers. Chris Echols has held CFO, COO, and CEO seats inside law firms, and 3sixty works only with law firms. See how a fractional CFO engagement works.
Build the budget your firm actually needs
A budget is not a formality you get through before the holidays. Done right, it is the tool the partners use all year to decide what the firm does next.
If you want help building one, let’s talk. A 30-minute conversation about your firm and where you want it to go, with no pitch deck and no pricing until we understand the firm. Book a consult, call (404) 398-3888, or email chris@3sixtyconsultinggroup.com.