In my many years of managing law firms of all shapes and sizes, budgeting is often looked upon by the lawyers as a chore and a paper exercise which quite often, once prepared, sits in the bottom drawer of the desk and is only dusted off when it comes to looking at the next year’s budget. Sound familiar? This apathy to use an important annual strategic financial tool effectively is an exercise in futility and frankly a waste of time for all concerned. It is also not a very smart way to run a financially savvy business.
There are three basic ways for a legal business to budget:
- Incremental Budgeting – Taking the previous year’s numbers and adding an incremental percentage factor (usually between 2% and 10%) to revenues and expenses. There is no real science or purpose to this and it is simply a yardstick of what the firm wants the Fee Earners to produce and the potential cost associated with this. In other words, it’s a “production target” with attributable “production costs,” with no real thought or strategic intent. Often this type of budgeting has very little accountability, and there is no real consequence if the targets are attained or not.
- Activity-based budgeting – This is a very intricate and detailed way of budgeting whereby past activities are broken down into their component parts and a profile is built for the nature of work/product in the coming year. In my experience, this is almost impossible to do accurately in a legal business (or any professional-services business, for that matter). This is because legal firms, in general, do not have any idea of the true unit cost per hour for individual lawyers; we are dealing with human capital and there are many variables involved – including poor time recording and time management.
- Zero-Based Budgeting (ZBB) –This method is intended to create a budget for each fiscal period from scratch (hence the term “zero-based”), with little reference to the past period. Enabling ZBB requires the firm and its management to focus on a vision and strategy. This is then formalised in a simple business plan for the coming year(s), which is then broken down into revenue targets and the various activities of people, other resources and capital expenditure in order to deliver on the turnover, vision and strategy. This more strategic method of budgeting helps focus the mind of the stakeholders of the business in regard to what they are trying to achieve in the short and medium term, and to prioritise the business investments and opportunities accordingly.
There are a number of advantages to adopting the ZBB method:
- It promotes the creation of a vision and strategy for the firm;
- This then is filtered down into the various practice and industry groups;
- It requires accuracy rather than a broad-brush approach;
- It creates efficiencies by focusing on current and future aspirations and goals rather than on prior results. In other words, it’s a forward-looking tool;
- Coming up with the budget requires significant co-ordination and consultation within groups.
There are also a few disadvantages:
- It can be time-consuming and rather involved;
- The firm may lack expertise in doing it well;
- It requires staff time.
The perceived thinking is that ZBB is just a cost-cutting exercise but this is an ill-advised and too simplistic view. If ZBB is used strategically, developing both the revenue targets and the costs associated with delivering those targets, it becomes a very powerful tool to grow a business.
It is my view that many law firms (especially small- and medium-sized firms) do not have much focus on what they are trying to achieve in the short and medium term as they are too caught up in their day-to-day activities. Adopting a ZBB approach forces the stakeholders to have a focused business plan outlining what they are trying to achieve in the next 12 months (and beyond). This “game plan” coupled with the ZBB becomes the “play-book” for the year.