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It’s an annual exercise for many law firms — the budgeting process. Whether it occurs at year-end or on some other cycle, an effective budget is about more than careful preparation. At a minimum, budgets should be used to plan or forecast the expected results for the year, including partner incomes. But the work shouldn’t stop there. Budgets should also be used on an ongoing basis to monitor and manage costs by comparing actual expenditures against the budget throughout the year, and prioritizing expenditures accordingly. When preparing a budget, you should start with a clean slate. Resist the urge to just take the prior year’s actual results and make slight adjustments for inflation or other known or anticipated changes, such as in head count. It’s important to take the time to talk to the partners and other firm employees to get a full understanding of their needs. You should use the budgeting process as an opportunity to ascertain the desired level of service, such as the appropriate level of secretarial and paralegal staffing. Determine which functions or practice areas are critical to serving existing clients or attracting potential clients, and find out what the competition is doing. You should anticipate business trends in the coming year, as this can impact your resources in many areas. Assess what your technology needs are and how to get the most value for any purchases. From this analysis, you can develop a plan that sets the stage for the entire budgeting process. GUIDING PRINCIPLES Once you’ve identified the needs of the firm and the service level expectations of both the clients and lawyers, there are some principles to keep in mind. First, it is extremely important that those responsible for managing the budgeted activities be involved in the budget’s preparation. In small firms that management responsibility often rests solely with a legal administrator. Other managers, if any, should also assist in the preparation of the budget. If these managers have had little or no input, it will be difficult to hold them responsible for the financial results and for any variances from the budget. However, if they take an ownership interest in the budget, you will be more successful in controlling costs. Second, the budget needs to be detailed. Carefully document each assumption, as this will enable you to analyze the actual-to-budget variances. The budget must include an accurate monthly breakdown. It is a big mistake if you only budget on an annual basis and then divide the annual totals by twelve to get the budget for each month — revenues and expenses are rarely spread evenly throughout the year. Unless an attempt is made to accurately budget the actual monthly cash inflows and outflows, you will not be able use the budget to anticipate and arrange for your borrowing needs or predict when you will be able to distribute excess cash to the partners. Third, you should build in a certain amount of conservatism. Law firms usually distribute all of their profits as partner compensation. Therefore, it is important not to overestimate net income as it can lead to disappointment, or worse, personal cash flow problems for the partners. As it is easier to predict expenses accurately, budget conservatism should usually be achieved by lowering the billable hours estimates and the correlated revenue. IMPLEMENTING THE BUDGET So now that you have completed the budget to your satisfaction, how do you get it approved? For this, you should refer to the agreed assumptions and levels of service developed during your firmwide discussions at the beginning of the process. Comparisons with prior budgets and prior year actual results should be shown to support the new budget’s reasonableness. Once the budget has been approved, it is important to monitor and report the actual results against the budget in the coming year. This must be done monthly to ensure that everyone is getting current information. As budgets are only estimates, focus your analysis on year-to-date variances, as opposed to variances on a month-to-month basis. You should provide a sufficiently focused and concise discussion so that it is informative, yet not too detailed to cause the reader to lose interest. It can be effective to present graphs and ratios to summarize the variances and results, rather than just relying on the narrative discussion. Finally, you should provide a game plan for any necessary corrective action based upon the variances you are experiencing. Your objective in preparing a budget is to provide useful information for making decisions, not just for the sake of going through the exercise. If you focus on the process and push down the preparation and monitoring responsibility to the “grass roots” management level, you will find that you get a more accurate work product and are more effective at controlling the costs. THE DETAILS Here are some things to keep in mind: 1. Revenue should be budgeted by individual timekeepers. Unless there have been dramatic economic changes, generally you can reasonably estimate billable hours based on each individual’s total for the past two or three years. People tend to work up to a certain capacity in any given year, so basing it on past performance is as good a measure as any. 2. Use actual, not stated, billing rates. When assigning individual billing rates, you should use actual effective billing rates — which is the average rate actually billed, rather than any standard or stated rates. Also consider any write-downs and write-offs. 3. Build in a time lag. Most law firms use a cash basis of accounting, so it is important to build in a time lag when budgeting collections, especially in periods of significant growth or shrinkage. The time lag is typically at least 60 to 90 days from the date billed. 4. Budget personnel costs by individual timekeeper. Estimated bonuses should correlate with the billable hours estimates. Bonuses should also be budgeted for the month in which you expect to pay them. 5. Remember part-time or temporary timekeepers. For example, don’t overlook summer associates, law clerks and contract attorneys. Also be sure to include bar stipends or other amounts that may be payable to the individuals. 6. Personnel costs. Depending on the size of the firm, you may choose to budget these costs by staff type or function. Don’t forget any salary adjustments that may be made during the year. Certain benefit costs, such as payroll taxes, overtime and retirement plan contributions, can generally be budgeted based on a comparable percentage of compensation as experienced in the prior year. Michael Palmer is the director of administration for the California offices of Akin Gump Strauss Hauer & Feld. He can be reached at [email protected]

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