Most people think law firms are big-time money churners and have no financial stress. After all, legal fees are often expensive, and all that money must be easy to account for, right? But the truth is very different. Law firm finances are unique, and so are their financial bottlenecks. The very nature of the legal practice and profession, along with the uncertainty surrounding its outcomes, causes numerous complications in managing its revenue, expenses, and cash flow.
To efficiently manage the finances of a law firm, you first need to identify its unique challenges, including cash flow volatility and complex resource allocation, both of which are related to the profession’s intricate billing processes. Interestingly, the key to addressing these challenges is not taking on more clients, but rather streamlining existing and incoming revenue to create room to take on new cases.
Let’s understand in detail how its unique problems can have a profound effect on a law firm’s finances.
Financial Problems Unique to Law Firms
The biggest challenge any law firm faces is its billing structure. A law firm earns money through four distinct billing methods, each with its own unique characteristics. In some cases, more than one method is used, making bookkeeping and accounting even more difficult. Let us tackle them one at a time:
Flat Fee Billing
As the name suggests, under this fee structure, the client can pay all their dues upfront, as a single flat fee. While such fees are easy for clients and generate instant income for the firm, they cause inconsistencies in profitability. This is because, having already billed the client, it then falls upon the firm to make sure just enough resources are used to solve the case. However, there are times when more resources are needed; in such cases, the firm might face prospects of a loss or slowing profits.
Financial Management for Flat Fee Billing
Like in personal finance, a firm’s budget aims to ensure you do not spend more money than it earns. Prioritizing which expenses are more important than others cannot be ignored. Since the firm knows beforehand what its revenue will be under the flat fee structure, it can allocate available financial resources and create a budget that will maintain a smooth cash flow. The stability provided by such fees enables the firm to plan any growth activities for the business and offsets the problems created by other fee structures.
Hourly Billing
Some legal practices bill clients on an hourly basis. In this scenario, payment is either made monthly after the bill is sent to the client or upfront, with a retainer fee from which the law firm deducts its hourly billing. This ensures recurring revenue. However, the billing process is cumbersome for such a fee structure.
Financial Management for Hourly Billing
Hourly billing requires detailed time tracking of each associate and lawyer involved in the case, specifying the number of hours worked. Time tracking can be inefficient, as associates often track time inconsistently. Automating time tracking, billing, and accounting software can automatically generate insights for billing.
Contingency Fees
The outcome and timeline of legal cases are unpredictable. You never know how much time it will take for a case to settle, depending on the complexity of the case. And you won’t get paid until settlements are finalized in contingent cases. Some may resolve quickly, while others may take months or even years. Such lengthy timelines require significant funding and tight expense planning to continue meeting payment obligations, as the law firm is utilizing its resources, which are not free.
Financial management for contingency cases
Managing finances for contingency cases requires forecasting and cash flow management.
- Forecasting: Although it is difficult to determine the settlement timeline for some cases, one can make an educated forecast of a minimum and maximum timeline, similar to cases that have been settled in the past, along with their win rates. This can provide a basis on which the law firm can estimate the cost of salaries and other expenses.
- Cash flow management: Once you have an estimated cost, consider creating a contingency reserve for that case to fund those expenses until you receive payment. The reserve amount is limited, which means you need to track your short-term cash flow patterns and identify areas of improvement.
- Diversify case types: Another solution is to diversify your case types into those with regular cash flows or a quick turnaround. The regular cash inflow from these cases can offset the cost incurred in contingency cases.
A law firm has unique financial challenges that need specialized financial management solutions. A skilled financial advisor specializing in legal practices can understand revenue and costs more effectively and devise a practical financial plan, executing it efficiently.
Contact Ford Keast LLP in London to Help You Manage Finances for Your Legal Practice
Talk to a professional accountant to help you prepare specialized account statements and key performance indicators to track costs and revenue, which can be used for budgeting and forecasting. At Ford Keast LLP, our accountants and financial consultants offer a range of services, including preparing financial statements, financial planning, and forecasting. To learn more about how Ford Keast LLP can provide you with the best accounting and financial consulting expertise, contact us online or call us at 519-679-9330.
