For Solicitors: A guide to creating cashflow projections for a new law firm

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Starting a new law firm requires adequate planning and preparation to ensure sustainability and long-term success. One essential aspect of planning is preparing cash flow projections – ideally for the first three years of the firm.

This guide will provide solicitors wishing to start their own law firm with a step-by-step process to creating a three-year cash flow projection.

1. Income forecast for each year
   The first step in cash flow projection is estimating the income of the law firm for each year. All revenue streams the firm will receive should be identified and realistic estimates provided for the fees/revenue each stream can generate. This can be done on a monthly or annual basis.Possible sources of income may include hourly billing rates, fixed fees, subscription fees, client retainers, contingency fees, and success fees. The estimated income should factor in the probability of collecting revenue from each source and the average payment processing time. The sources of income should be arranged in order of priority, with realistic revenue projections for each source.
2. Expenses budget for each year
   The next step is to create a budget for expenses that the law firm will incur. This should include all expected expenses for the firm, such as office rent, utilities, business equipment, salaries, marketing expenses, and solicitors’ professional indemnity insurance (and other insurance costs).Office Rent: The rental cost of the office space should be researched and rent increases should be expected every two years. Utilities should be budgeted for- the cost of utilities generally depends on the size of the office space to be occupied.Salaries: Expenses should include salaries, bonuses, and employee benefits of all required staff. Salaries should be compared to industry average rates of salary and benefits and the principal/s or partners should also be appropriately remunerated (otherwise, the plan may not be regarded as sustainable).Equipment: Costs should be budgeted for all required equipment and furniture, including computers, printers, stationery and any other necessary business equipment and this should be reviewed regularly.Marketing and Advertising: There should be a budget for marketing costs which will typically include, website design and maintenance, social media management, networking costs, printing brochures and business cards, and advertising costs.Expenses should be factored into each period, and it is essential to identify fixed and variable costs in the forecast.Professional indemnity insurance is essential for all law firms, and typically a significant cost – it is important to provide a realistic estimate / budget for this cost. Solicitors professional indemnity insurance provides the mandatory cover required to comply with the regulatory requirements and protects firms (and their clients) against potential financial losses incurred as a result of the professional negligence of the firm. The amount of professional indemnity cover depends on the fee income revenue, level of risk involved in the practice area, the type legal entity and any adverse/claims history. The Regulated Risks team will provide guidance on the cover required.
3. Cash flow statementThe third step is to draw up a cash flow statement based on the income forecast and expenses budget. A cash flow statement provides a summary of cash in and out, including cash in from revenue generated and cash out due to expenses incurred. The statement helps identify the amount of cash required to meet the monthly and annual operating costs of the law firm.Concepts that should be factored into the cash flow statement include accounts receivable and payable, cash sales, and all operating costs. A three-year projection of the cash, investment, and other activities is also necessary to create a cash flow statement and the effect of these activities on the firm’s liquidity.A cash flow statement helps in identifying the need for financial investment and helps with decisions around staffing, investment in marketing initiatives etc.
4. Break even analysis
   A break-even analysis helps to calculate the point in time when the law firm’s income exceeds all expenses. The formula for a break-even analysis is as follows:Break-Even Point = Fixed Costs ÷ (Sales Price per Unit – Variable Costs per Unit)Fixed costs are expenses that are constant no matter how many units are sold. These costs typically include rent, salaries, and insurance premiums. Variable costs are expenses that change with the amount of revenue generated. These costs may include legal expenses, marketing expenses, and stationery.The break-even analysis helps to identify the minimum amount of revenue required to cover business expenses and to focus on strategies that will cover the expenses in a shorter period. This helps determine the number of clients needed to reduce the firm’s risk and to guide pricing strategy to achieve the desired profit margin and ensure sustainability.

In summary:
Creating a three-year cash flow projection is necessary to ensure that a new law firm can manage its resources and finances effectively. Breaking down the forecast into smaller and manageable periods such as monthly, annual, and by financial year assists in identifying potential shortfalls and creating strategies for efficiency and success.

A cash flow statement shows how the business created revenue and how it spent it, indicating an overall assessment of the business’ financial position and whether the business has enough funding to sustainably finance future operations and meet its obligations (including, importantly its Solicitors PI costs, possible excess payments and future run-off costs).

Finally, the firm must create a break-even analysis to determine the point at which revenues from the firm exceed all expenses indefinitely. The analysis helps the firm to focus on the most effective pricing structure for services, identify expense reduction opportunities, and focus on strategies to make the firm profitable and sustainable.

Written 19th January 2024