Step 1: Define scope
You can't estimate costs until you know exactly what you are budgeting for, so the budgeting process must always begin by defining the scope of a matter.
The best statements of scope simply summarize the project objective, the deliverables you will provide, and the "carve-outs" that will be specifically excluded. You may also want to add key assumptions, the process for accepting work, and the name(s) of the key decision maker(s).
If you are tempted to draft a bullet-proof agreement that specifies dozens of exceptions and "carve-outs," don't do it. If the agreement looks too much like you are trying to protect yourself at the client's expense, it could lead them to hire another firm that is easier to do business with.
If you are uncertain how clients will perceive your draft, ask a business oriented non-lawyer how they would react if they were the client.
Step 2: Select the budgeting approach that fits your situation
The best budgeting approach for a $5 million fixed price proposal to a new client requires far more detail and certainty than a $15K new matter with a client you know well.
The Project Management Body of Knowledge (the official source for professionals who want to be certified by the Project Management Institute) lists nine different approaches to budgeting, and other experts have identified many more. For legal budgets, it is simplest to think of three basic approaches: low detail, medium detail, and high detail budgets. Each is the best approach some of the time.
Low detail budgets are often referred to as "ballpark" or "rough order of magnitude." They are based on past experience, and are typically used early in a project to decide whether to proceed on a certain course or not. The good news is that they can be generated promptly when a client asks "How much will it cost to..." The bad news is that these estimates are often wrong but clients still believe them.
If you guess too low, clients may refuse to pay the actual cost of the work because they perceived your estimate as an upper limit. If you guess high to reduce this risk, you may lose the work because the client will find somebody who gives an unrealistic lower estimate. That's why low detail budgets should be used sparingly. They are most useful for dealing with sophisticated clients who trust you, and who won't hold your hand to the fire if you guess wrong.
Medium detail budgets are often called "top-down" or "analogous" budgets because they are based on rough mathematical calculations derived from lessons learned in past experience. If a past case required 10 depositions and this one is similar but will require 20, simply double the cost for the depositions portion. The key here is factoring in the differences between the past situations and the matters you need to deal with now. One way is to define a "complexity factor" comparing the present situation to past experience. For example, if you think that client demands, work processes and the team members you will work with will make this twice as complex, multiply the old price by two. Medium detail, top-down budgets are most useful in the initial planning of a matter.
High detail budgets are obviously the most accurate approach, and also the one that takes the longest time to calculate. They are called "bottom-up" because they start from the list of all the tasks and deliverables that must be finished to successfully complete the matter. The cost of each task is estimated separately, and all tasks are summed to come up with the total projected costs, as described below.
Step 3: Review best practices and estimate costs
My Legal Project Management Quick Reference Guide lists a number of best practices professionals use in estimating budgets, starting with remembering that it is human nature to be optimistic; don't underestimate how long tasks will take.
Read more about Step 3 on the Legal Business Development Blog.