How to Forecast Your PI Firm's Income and End the Feast or Famine Cycle (Ep. 174)
If you run a contingency practice, you already know the feeling: months of nothing, and then a settlement lands in your bank account, making everything look great just right before it disappears again. On this episode, host Darren Wurs shows you how to see that money coming months in advance, so that the feast-or-famine cycle stops running your firm, and you start running it.
Understanding the Unique Challenges of Contingency Law Firms
Contingency law firms operate under a very different model than hourly firms. In the hourly model, you work, bill, and get paid in 30 to 60 days. However, contingency firms often front hundreds of thousands of dollars in costs and wait two to three years to see a dime. This can lead to unpredictable income, making financial forecasting essential for survival and growth.
Why Financial Forecasting Matters
The cost of flying blind in a contingency firm is exceptionally high. Many firms don’t know the total value of their caseload, nor can they predict when their revenue will be realized. They end up guessing at when funds will come in, which creates enormous financial risk. With recent challenges like tort reform and clogged courts, the time to settle cases has increased significantly. Understanding your revenue pipeline is not just a nice-to-have; it’s a necessity.
Building Your Financial Forecasting System
Step 1: Establish a Pipeline Report
The centerpiece of your financial forecasting system should be a pipeline report or case inventory report. This report will help you visualize and manage your active cases effectively. For every active matter, you should capture the following fields in your case management system:
- Case type
- Expected resolution or settlement date
- Expected gross settlement amount
- Contingency fee percentage
- Probability of winning or settling
Step 2: Determine Expected Case Value
To forecast effectively, you need to calculate the expected value of each case—not just its potential value. This involves assessing the probability of winning and the likely settlement amount. For example, if you determine an 80% probability of winning and a potential settlement of $500,000, the expected value for that case would be:
Expected Value = Probability of Winning x Potential Settlement
Expected Value = 0.80 x $500,000 = $400,000
This expected value will be crucial for your revenue forecasting.
Step 3: Calculate Expected Fees
Once you have the expected value of each case, it’s time to calculate the expected fees. Multiply the expected value by your contingency fee percentage. For instance, if your expected value is $400,000 and your fee percentage is 40%, your expected fee from that case would be:
Expected Fee = Expected Value x Contingency Fee Percentage
Expected Fee = $400,000 x 0.40 = $160,000
Step 4: Account for Settlement Probabilities
Not all cases will settle; some will go to litigation. To refine your forecast, you’ll need to factor in the percentage of cases that settle versus those that go to litigation. If, for example, you estimate that 80% of your cases settle and don’t go to litigation, you would reduce your expected fee accordingly:
Final Expected Fee = Expected Fee x Probability of Settlement
Final Expected Fee = $160,000 x 0.80 = $128,000
The Importance of a Strong Financial System
A well-structured financial forecasting system allows contingency law firms to see their cash pipeline clearly. By following the steps outlined above, you can ensure that you have a clear understanding of your revenue and can plan ahead effectively, minimizing the risks associated with cash flow fluctuations.
Key Takeaways
- The financial forecasting process is essential for contingency law firms to manage their revenue effectively.
- Establishing a pipeline report helps visualize active cases and their potential values.
- Calculating expected case values and fees allows for more reliable revenue forecasting.
- Understanding the probability of case settlements is crucial for accurate financial planning.
Resources:
Profit First - Transform Your Business from a Cash-Eating Monster to a Money-Making Machine by Mike Michalowicz (Book)
Simple Numbers by Greg Crabtree
Simple Numbers 2.0 by Greg Crabtree
Law Firm Financial Reporting Template Pack (Exclusive content)