What is a break-even analysis?
Law firms, like most businesses, are created to generate a profit for the partners.[1] Generating revenue alone does not guarantee that firm will earn a profit because businesses only generate profits when their revenues exceed expenditures.[2] The “break-even point” is the point at which the revenues begin exceeding the firm’s expenses.[1][2]
The first step in a break-even analysis is to determine the source for your revenue stream and accurately estimate your expected annual revenues.[3][4] This involves looking at the area of law you are going to practice, the fees you plan on charging for your services, and estimating the number of clients you think will engage your firm annually to get the firm’s estimated revenues.
Once you have estimated your revenues, you then must determine what your fixed costs and variable costs will be. Fixed costs are expenses that you must pay no matter how many clients your firm has, and include things such as rent, payroll, copier costs, internet, etc.[5] Variable costs are the expenses associated with the provision of services to a specific client and are typically billed to the client as a hard cost.[6]
If your firm plans on paying for variable costs and invoicing the client for reimbursement, you will need to include variable costs into your break-even analysis.[7] (This is why, whenever possible, it is best to get an advanced fee deposit from the client and pay the client’s hard costs directly from the trust funds.) If your firm is planning on paying for client hard costs from client trust funds only, then you will do not need to include them in your break-even analysis.[4]
The point at which the projected revenues equal the estimated fixed and variable costs is your firm’s break-even point. If your projected revenues are more than your estimated fixed and variable costs, then your firm is projected to earn a profit. The following is the technical formula[4] for calculating the break-even point:
Annual break-even point =annual fixed costs/((estimated annual revenue – hard costs paid out of pocket to be reimbursed by client)/estimated annual revenue)
Monthly break-even point = (annual fixed costs/((estimated annual revenue – hard costs paid out of pocket to be reimbursed by client)/estimated annual revenue))/12
References
1. How to do a break even analysis
2. Break even point
3. Finding a niche for starting a business
4. Break even analysis before starting your business
5. Fixed and variable cost guide
6. Variable costs in the consulting industry
7. Top 10 strategies for law firm profitability