Profit First for Small Law Firms: How To Get Started
Running a small law firm comes with its own set of challenges, especially when it comes to managing finances. The Profit First methodology, introduced by Mike Michalowicz in his book Profit First, is designed to help business owners, including law firm owners, achieve sustainable profitability. Here’s how you can implement Profit First for small law firms and lawyers to ensure your law firm’s financial health.
When we implemented this in the law firm, we found it so much easier to manage the money, after the initial challenges of figuring out the best way to set it up and use it. By following these principles you will definitely see the benefits of implementing profit first for lawyers.
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What is Profit First?
Profit First is a cash management system that flips traditional accounting on its head! Instead of the usual formula:
Revenue – Expenses = Profit
Profit First teaches the concept of:
Revenue – Profit = Expenses
This simple shift ensures that your law firm prioritizes profit, leading to better financial growth. The methodology is detailed in the book, with step-by-step guidance on how to make money as a lawyer more effectively. In order to make your transition easier, I am providing a profit first summary below so you can get started.
What is the Purpose of the Profit Account?
Below I will explain about setting up a profit account, but first let’s talk about what the purpose of the profit account is. This account serves two main purposes:
- Monetary payment to the owners of the business (equity)
- Cash holding for emergencies
Steps to Implement Profit First For Law Firms
Set Up Multiple Bank Accounts
The first step in implementing Profit First is to set up multiple bank accounts. At a minimum, you should have:
These are the basics you should have. Some businesses will also set up separate bank accounts for payroll, fees/memberships and disbursements.
TIP: Set up your profit, and tax accounts at a separate bank so that you are not tempted to use it. I recommend an online bank account with no monthly fees. You will notice in the book that they have two extra accounts for profit and taxes. I found it best to eliminate these two steps as they are just a ‘holding account’ before you transfer the funds out.
Determine Your Profit First Allocation Percentages
Analyze your current financials and determine appropriate percentages for each account. A common starting point is:
- 5% Profit
- 50% Owner’s Compensation
- 15% Tax
- 30% Operating Expenses
If you run your business from home, you may find that you do not need as much in the operating expenses account.
Transfer Funds Regularly
On a bi-weekly or monthly basis, transfer funds from the Income Account to the other accounts based on your predetermined percentages. This regular practice ensures you consistently prioritize profit. Once the transfers are completed, your income account should have $0 in it.
The book recommends transferring your funds on the 10th and 25th of every month. Do what works best for your business model as long as it is consistent.
Adjust and Monitor
As your law firm or business grows, adjust your percentages. Regularly review your financials to ensure the allocations still make sense for your business. The book provides details on how to figure out your ‘Target Allocation Percentages’ for the different accounts. Once again, this will depend on your business growth plans.
For a solo lawyer or business owner that works from home, you may find that your operating expenses do not change much – so the allocations may remain the same for this account.
Quarterly Distributions
Following the Profit First principles, it is time to pay yourself! Now is the time to pay yourself your first profit distribution. You are the business owner and you deserve those profits! Mark in your calendar to pay yourself on the following dates:
April 1, July 1, Oct 1, Jan 1
On this date, pay yourself 50% of the money in the profit account. This is your payout! The remaining 50% stays in the account as the reserve and accumulates. The following quarter you do the same – pay yourself 50% of all the funds in the account, not just what was added during the quarter.
Just remember that the funds you withdraw as your profit distribution is yours! Do not invest it back into the company – use it for you – it is your reward.
It is recommended that you increase your percentages by 3% in your accounts. you can choose to increase your profit account by 3% or split it between your profit, taxes and owners compensation account. The goal is to only increase it up and not go backwards. You are distributing profits quarterly, which forces you to find ways to operate your business more efficiently.
Tax Time
After your first year, you may find that you did not allocate a high enough percentage towards your tax account. If that’s the case, this is the only time you can take money from your profit account. Ensure that you plan accordingly by increasing the percentage into the tax account and decreasing your percentage into your profit account for the following year.
If the reverse applies and you have money left in your tax account then woohoo! Take that extra money and move it to your profits account to be part of your profit distribution.
Tips and Tricks for Profit First for Lawyers
Start Small and Scale Up
If you’re a solo lawyer or running a small law firm, start with modest percentages and gradually increase them. This allows you to adapt to the new system without financial strain. If you are starting a brand new law firm or business it’s okay to start at 1% or even 0% profit. It’s about starting a habit of distributing money to the appropriate buckets.
Online Tracking & Banking
The easiest way to get started with the Profit First methodology is to track everything on a spreadsheet. I created a crazy looking spreadsheet that works great for tracking. I’ve yet to find any online programs that automatically calculate the allocation percentages and transfer them for you. So it still requires a bit of manual work.
Review Your Expenses
Implementing Profit First highlights unnecessary expenses. Regularly review and cut costs that don’t contribute to your law firm’s growth. You’ll be amazed how you can run your business on 10% less when you plan accordingly.
Trust Accounting Responsibilities
For law firms, it’s crucial to maintain separate accounts for trust funds. Trust accounting must be meticulous, ensuring that client funds are never co-mingled with operating funds. There is no effect or inclusion in Profit First with these funds.
Use Professional Bookkeeping Services
A bookkeeper can help you manage multiple accounts and stay on top of your financials. This is especially beneficial for small business owners who may not have the time or expertise to handle complex bookkeeping, especially lawyers. When you are starting your business, you may be able to do your bookkeeping yourself, but the time will come when you need someone to take it over for you, especially for law firms.
Why Profit First Works for Law Firms
Profit First for lawyers is particularly effective due to the nature of legal services. Revenue can be unpredictable, and expenses can quickly spiral out of control. By implementing Profit First for lawyers, you create a financial buffer that helps you weather slow periods and plan for future expenses.
Implementing the Profit First steps can transform how your law firm handles money. By prioritizing profit, you ensure the financial health and sustainability of your business. Start small, adjust as you grow, and don’t hesitate to seek professional help to manage your accounts. With these tips and tricks, you can make Profit First work for your small law firm and achieve a healthy profit margin.
Profit First for small law firms is more than just a financial strategy; it’s a mindset shift. By focusing on profit first, you can build a thriving law firm that not only survives but flourishes. Set up your accounts, start allocating and start your journey towards financial stability today. I hope this summary helps you get started. Feel free to reach out if you need help getting everything set up.
