We’ve spent this month on the blog going through different budgeting philosophies, including what we’ve seen work, and why. We’ve talked about both Profit First and YNAB as great budgeting strategies for law firms. Today, we bring you an intro to how to implement Profit First for your firm. Of course, to get the most out of it, we definitely recommend you read the book (affiliate link).
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Today we’re continuing our series on law firm budgeting. Our series started by explaining why traditional budget forecasting is for fortune-tellers, not lawyers. Instead, lawyers should implement a budget earmarking system to help them make great financial decisions for their firms. Then, we took a look at one such system, Profit First. Today, we’re looking at another budget earmarking system lawyers use to turn poor cashflow into abundant profits, and that’s YNAB.
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Hopefully you’ve read our post about budget forecasting versus budget earmarking. And now you’re interested in learning more about budget earmarking. Today, we’re going to learn about one kind of budget earmarking: Profit First.
Profit First is a budgeting method Mike Michalowicz developed and described in his best-selling book, Profit First (affiliate link). In short, the idea is that business owners do business backward; they pay all their expenses, and pay themselves whatever is leftover. In other words, they’re taking their profit last. Instead, Michalowicz encourages business owners to take their profit first. Then, the business can run on what’s left over.
This is a great concept. Because none of us started our law firms just so we could work hard and pay the law firm’s bills and go home empty-handed every night. We started our firms so that we could make a paycheck for ourselves, on our own terms. So, we need to prioritize that paycheck, and take our profits first.
Profit First is a way of budget earmarking for your law firm. In other words, Profit First is one method of taking the money you’ve made, and allocating it to different bank accounts within the firm, with each bank account having a specific spending purpose. And of course, the first allocation you make is to yourself – you take your profit first.
It works well for a lot of business owners because it presents your firm’s finances to you in a way that many business owners naturally run their businesses – by bank account. It’s common for a busy law firm owner to make financial decisions by simply logging into their bank account and seeing what funds are there. If the bank balance covers the expenditure I want to make, then I make it. If not, then I don’t.
The problem with “bank balance” financial decision-making is that we tend to rob ourselves of the opportunity to save up and really invest in both ourselves and in our firms. It’s like the “see-food” diet – if I see food, I eat it. Except in this case it’s “see-money” spending – if I see money in the account, I spend it.
There’s nothing wrong with a “see-money” mentality – it’s probably one of the most common money mentalities among small business owners. What Profit First does is harness that “see-money” instinct to help us manage our money smarter. It does this by allocating money to different bank accounts, so that I don’t see all my money in one place.
Profit First gives law firms a budgeting tool that works wonders short-term, as firm owners begin to implement a budget that actually works for them. But, it’s even better long-term. Because typically, when we start a Profit First plan, we need to meet our firm where it is, and not where we want it to be.
Oftentimes we’re overspending on operating expenses and underpaying ourselves, so over time we want to slowly reduce our operating spending and increase our own paychecks. By making small, incremental changes in how we run our firm, and how we earmark our money, we’re able to make those long-term goals a reality. And Profit First gives us the framework we need to see where our money is, where it’s going, and what those changes are that we need to make. It helps us forge a path from where we are now, to where we want to be.
Profit First is great for any law firm owner that tends to engage in “see-money” spending. It’s also great for firm owners who don’t like to (or more often don’t have time to) deal with more granular budgets or more detailed numbers. It does this by dividing your money into just 6 or so different budget categories. Finally, it’s hugely helpful to those of us who need to see real money in real bank accounts, because theories or allocations on paper just don’t cut it.
But Profit First isn’t the only method of budget earmarking. Stay tuned to our blog to learn about the YNAB budget, and see if it might be right for your firm.
If you’re not already on our mailing list, be sure to sign up. We’ll soon be posting a DIY step-by-step intro to getting started with Profit First.
For those of you who’d like a little more support and guidance, as well as a plan to make Profit First work for you both short- and long-term, Skepsis would love to help. Book your free discovery call today.
When most lawyers think of budgeting, they think of budget forecasting. This is is the thing you do when you sit down each year, see what you spent on the different expense categories in your books, and then plan out what you’re going to spend in those categories in the coming year. You put together a great spreadsheet, or a nice report, so you know exactly where all your money will come from and where it’ll go each year, and maybe if you’re super on it you’ve broken it down by month. In other words, what you’ve done with your budget forecast is plan the upcoming year. You’ve just tried to predict the future.
Let’s be honest with ourselves. Traditional budgeting is – I’m going to just say it – fortune-telling. You might as well be spending time searching for the pot of gold at the end of the rainbow, or betting on the World Series.
Nothing showed us that more clearly than 2020. If you had a traditional budget forecast for 2020, you know exactly what I mean. Your budget forecast went out the window as soon the first shutdown order hit. Or when the courts shut down, so that huge con fee that was right in front of you was suddenly pushed out at least six months. Whatever income and expenses you had forecast for 2020, 2020 turned them on their heads almost overnight.
And it’s not just you. Law firms, and even Fortune 500 companies and governments, that spent tens of thousands or more on budget forecasting experts, research, and analysis found that their budgets were no better than expensive scratch paper by April. It’s also not just 2020. Even before 2020, studies show that budget forecasts are typically off by significant margins. (See Aaron, Henry J. 2000. “Presidential Address—Seeing through the Fog: Policy- making with Uncertain Forecasts.” Journal of Policy Analysis and Management 19 (2): 193–206.)
There’s no doubt that budget forecasting has its place. Although a budget forecast tells you precious little about where you’ve been or where you’re going, it can be a useful tool to help you figure out where you want to be – the law firm’s financial goals. Budget forecasting can be a good aspirational and goal-defining tool. The key is to keep it at the thirty-thousand-foot view, and not get bogged down in the weeds. If our aspirational budget is the forest, then all those individual accounts with their precise numbers are the trees.
Another problem with forecasting? It can give us a false sense of security. When we forecast, it’s all too easy to make up for a large purchase on the expense side, with a good month on the revenue side. Maybe April is typically our firm’s best of month of the year. Well, let’s forecast another good April, and voila! That big expense is suddenly justifiable. And then April hits and we spend it – and the income doesn’t materialize. At that point, we’ve created a cashflow problem for ourselves.
Beyond setting a general direction, a budget forecast tells us very little about the law firm. It also is not particularly helpful in making financial decisions. And really, the point of any financial data about your firm is to help you make sound financial decisions.
So now is a great time to completely rethink law firm budgeting. Forget the traditional, “here’s what you should spend in which categories this year” budget forecast. It’s true, traditional budget forecasting can have its place, but before doing any forecasting, we recommend most firms do a different kind of budgeting entirely. It’s called budget earmarking.
With earmarking, we’re not trying to predict the future. Instead, we take known, measurable quantities – that is, dollar amounts – from the past, and we earmark those dollars for the future. So there’s no guesswork, and you always know exactly where your budget stands.
There are two kinds of budget earmarking that work well for law firms, and give you real, hard numbers – not future guesses – that you can use to make financial decisions. More about that is yet to come, so be sure to sign up for our newsletter to learn the secrets of successful earmark budgeting for law firms.
Would you like professional guidance to set up a great budget for your law firm? Would you like to make financial decisions for your firm quickly and easily, and angst-free? Set up a discovery call with Skepsis today.