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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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.