The True Value of Budgets

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Alex at The Law Factory consider the importance of financial planning and budgeting.

As I write this article, we are amidst what many deem a “cost of living crisis”, where “inflation is out of control”. These are very strong terms, but nonetheless the country is having to do what it can to pull through in this post-pandemic era. Companies are having to review how they work, for example where staff are now working in a “hybrid” format, part time at home, part time in the office. Companies should also be taking this time to review their finances and their budgets.

Many firms do not have an ongoing budget or have never done a formal budget. Considering the issues we are presently facing, this can be quite a risky position to be in. Management within the firm should work directly with the cashiers to generate a budget which is realistic and attainable.

The starting point is always the hardest part. It can be difficult to know where to begin. My recommendation is to export a profit and loss report from the accounts system and have a look at the last six to twelve months and see what the “actuals” were. What did the company turn over and what was the expenditure in each area? It is at this point that the cashiers need to review each account and ensure that there are no posting errors or inaccuracies that could contribute to wrong decisions being made when preparing the budgeted figures.

Once management and the cashiers are content that the figures are accurate and reliable, it is then time to start thinking about setting realistic targets for each account on the budget.

I always recommend starting with turnover (sales/fees). It’s usually the hardest one to get right because there are many elements involved in coming to the correct figure. In theory we could take an average of the last six months and use that as our monthly figure. It’s the easiest way to get a reasonably accurate figure, however when budgeting turnover it is often a good opportunity to look deeper. I recommend reviewing the fee earners who work for the firm and calculating what their billable hours/targets should be. If you work on a time recorded basis for all work, this should be straight forward and can simply be rendered from the case management system. If the work includes a lot of fixed fee work, determine how many fixed fee bills are achievable for those staff members and incorporate that figure too. Have meetings with fee earners and department heads to determine what is reasonable and achievable for chargeable and non-chargeable time. Once monthly targets have been agreed per fee-earner, total them and add that as the monthly budgeted figure. Pay special attention to future months and potential starters and leavers and adjust those future months accordingly.

After the income section, look at the bulk of the P&L which are the individual expense lines. Much like the income, there are a few ways the budget here can be generated. You could take the profit and loss at face value and take an average of the last six months, then extrapolate to the end of the year. I think to make savings however, it is important to again, look deeper. This is a good opportunity to review how much is being spent with each supplier. It is worth speaking to the cashiers to see if there is any un-necessary expenditure such as subscriptions or services that can be cancelled. Reviews such as these often highlight expenditure for things that are no longer required by the firm and have been overlooked. It is also an opportunity to speak to existing suppliers and see if reductions can be made to services or the cost of those services, even potentially switching suppliers to save on expenditure. An comprehensive expense review certainly takes longer but will help with understanding and lead to costs savings in the long term.

Once the overall expenditure reviews and negotiations have been made, the cashier will need to go through each nominal account and agree what the monthly figure should be, incorporating any adjustments/savings. It is also important at this stage to predict what is likely to be invoiced and in which month. For example, accountancy fees are billed to the firm once or twice per year, so it makes more sense to target those months with the estimated invoice amount rather than take an overall cost and extrapolate it across multiple months.

After all lines of the budget have been completed to the end of the accounting year, it is important to go back over them and determine if the budget is sensible and realistic. It is also important to look at what the NET PROFIT is likely to be if the budget was adhered to. If the budget is sensible and we are not making enough in NET PROFIT, then something needs to change. This will need wider management meetings to determine whether there is a lack of turnover overall or whether the company is simply spending too much money on its operating expenses and where it should/could cut back.

Once the budget is agreed, it then needs to be used. It needs to be checked against the actual figures every month in a “variance analysis”. If there are large variances, we need to determine why they are there, working with the cashiers to get an explanation. In addition, any un-budgeted expenditure needs to be highlighted, and management needs to be made aware of any budgeted up-coming expenditure so they are satisfied that everything is covered. It is also important that the cashiers highlight where there may be dips in turnover due to staff absences or sickness.

The most important aspect of a budget is the information fed back to the management of the firm. Directors/partners need to clearly understand the position and profitability. Moreover, they need to understand the variances in a budget and why they have occurred. This will impact on future decisions on expenditure particularly. The budget will also give management a solid perspective about what is achievable in turnover and where savings can be made in expenditure.

I also recommend that the budget is reviewed quarterly and budgeted figures are altered accordingly should there be changes needed. Budgets which are not reviewed regularly eventually become obsolete and lose their value.

In conclusion, drafting a budget will give management a much better understanding of the firm’s position and potential profitability whilst hopefully increasing turnover and driving down expenditure in the process. It is something very firm needs during this difficult time.

Alex Simons MAAT
Outsourced Accounts & New Business Manager
The Law Factory LLP

Date:

Posted on 24.01.23