Forecasting expenses is an essential part of financial planning for any business, including law firms. Unlike revenue forecasting, which predicts how much money your firm will make in the future, cost forecasting predicts how much your firm will spend. In this blog post, we’ll explore why forecasting costs is important for law firms, and how it differs from forecasting revenue.
Why Forecasting Expenses is Important for Law Firms
Forecasting expenses is important for law firms for several reasons. First and foremost, it helps you plan your budget and allocate resources effectively. By knowing how much you are likely to spend in the coming months or years, you can make informed decisions about hiring, investments, and other expenses.
Cost forecasting can also help you identify potential financial challenges and adjust your strategy accordingly. For example, if you anticipate a significant increase in costs due to new requirements (e.g. a change of software, or wage increases, which are certainly the current problem), you can plan for this by cutting back on other expenses or seeking new revenue streams.
Finally, cost forecasting is essential for managing cash flow. By knowing how much you are likely to spend, you can plan for incoming revenue and ensure that you have enough cash on hand to cover expenses.
How Cost Forecasting Differs from Revenue Forecasting
While cost forecasting and revenue forecasting are both important parts of financial planning, they differ in several key ways. The most significant difference is the nature of the data being forecasted.
Revenue forecasting involves predicting how much money your firm will make in the future. This data is often based on past revenue performance, as well as external factors such as changes in the economy, client demand, and competition.
Cost forecasting, on the other hand, involves predicting how much your firm will spend in the future. This data is based on past expenses, as well as internal factors such as planned investments, changes in staffing, and new regulatory requirements.
Another key difference between cost forecasting and revenue forecasting is the level of control you have over the data being forecasted. While you may be able to influence your revenue by increasing marketing efforts or expanding services, you have more direct control over your costs. For example, you can choose to cut back on expenses or delay investments to manage costs.
That said, and unlike many other SME business cost cutting in a law firm is hard to achieve. Some costs (such as PII or Practicing certificates) cannot be avoided or delayed. Equally the single largest cost to most law firms is their wage bill, but there is no mechanism where you can avoid paying the staff for a month! Many law firms, therefore, use partners as the “balancing figure” on costs.
Best Practices for Cost Forecasting in a Law Firm
To effectively forecast costs in your law firm, there are several best practices you should follow:
- Gather historical data on expenses, broken down by category and time period.
- Consider internal factors that may impact costs, such as planned investments, staffing changes, and new regulatory requirements.
- Develop multiple scenarios based on different assumptions, such as best-case and worst-case scenarios.
- Involve key stakeholders, such as partners and solicitors, in the forecasting process to ensure buy-in and alignment.
- Regularly review and update your forecast to ensure accuracy.
Revenue vs costs budgeting
We talk here about revenue-based budgets and they are not less useful than cost-based ones. Doing both separately from another is usually the best answer – this creates a “top-down” budget (ie starting from revenue to create: “what looks reasonable for money we could earn”) and a “bottom-up” budget (ie starting from cost to create: “what looks reasonable for money we need to spend”). As Investopedia explains better than me, the ”budget gap” then becomes the difference between the two. So if your revenue budget says that £1m should be achievable, yet your expenses budget says you need more like £1.2m then you have a budget gap of £200k and can work “both sides” of the budget to close that gap – can we raise prices a little on the one side, and reduce marketing spend on the other side to bridge the gap?
You might also want to read our blogs on forecasting revenue and cash. If you have any questions or concerns about forecasting in your own law firm then feel free to get in contact.