How on earth does law firm cash dry up so quickly…so often?
“Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery”.
Charles Dickens, David Copperfield, 1849
All too often, over the last twenty-three years of my consulting to law firms, principals have bemoaned the apparent “sudden” tightening of cash availability…
The impacts vary with the situation of each firm, and range from just an uneasy feeling about the immediate future, to difficulty paying bills, and in particular, wages, and on to the ultimate, banks refusing to meet cheques and even calling in loans…
The banks classically demanding their umbrellas back during a decent downpour is every principal’s worst nightmare…the ultimate stress test…
Observing so many firms, and helping many out of “the crisis of the moment”, it is clear that often those with their hands supposedly on the levers do not fully appreciate how easy it is to allow cashflow to slow down…or at least they often seem to do not nearly enough about it…early enough.
Usually there is an enormous burst of activity to chase fees, bill unbilled WIP, collect more on account of fees and disbursement, and of course, cut costs, slashing expenses (yet again) and putting off staff…
Once the immediate crisis has passed pretty well everyone on the team goes back to operating exactly as they were before…happy that things have returned to “normal”…
Sometime systems are changed for the better in response to a cash flow crisis, but often not, and even when systems are changed there is all too often a complete failure to ensure that the systems are consistently followed in the future…
Despite a writer of the stature of Dickens making it so clear way back in 1849, I’m not at all sure that enough principals truly understand how little room there is to move, how thin their real margins are, and exactly how working capital is utilised in their firm…and this must impinge upon the effectiveness of their responses at least as much as other causes like perceived lack of time…
Working capital moves variably through a firm with different types of work, even when fee-earners, support and management are doing everything right…and, almost invariably, as a firm grows it needs more working capital, whether systems to optimise cashflow deteriorate or not.
There is a big range of reasons why working capital can become tied up longer than desirable, causing cashflow to slow and money, for the purposes you need it for, to be in short supply…
It’s just part of being in business that “things” will happen and suck in additional working capital, and you need to be geared for that...
However, a well-managed business does not need to run poor systems, or good systems poorly, such that working capital is tied up unnecessarily…
When you put a dollar of working capital into your practice, for rent, interest, wages, power, insurance etc, you do so with the intention that it will be tied up for a while, but come back to you after a reasonable time, with an element of true commercial profit attached to it as a reward for running the business well…
Let’s assume the margin is 10% (after principals salaries) and you do actually get the original dollar and margin back on time…what happens next?
Of course the original dollar almost always goes immediately back into the firm again as the next, never-ending, slew of expenses, leaving you with just 10 cents!
That paltry 10 cents has to be spread very thinly!
• Many firms will set aside a reserve for a rainy day…
• Some of it will be required to retire debt on principal and interest borrowings (the interest already being covered by the dollar invested in expenses)…
• More of it will be needed to be “left in” if the firm is growing and needs more working capital invested by partners’ retained earnings…
• Capital purchases are made that are not included in expenses and are “too small” to have borrowed specifically for…
• Hopefully there are some meagre cents left for a principal’s profit drawing…remembering that some firms also helpfully set aside funds for principals’ anticipated tax obligations down the track…so that’s more cash that doesn’t actually ever find its way into your pocket.
There are a lot more places cash can go even when we get it all right, but it can be seen that, as indicated earlier, there’s never much room to move.
Very often principals are asked to inject more loan funds back to the firm…and often they do that without doing nearly enough to address going forward why it was really necessary, and how it can be most likely avoided in future.
It’s obviously one heck of a lot worse if the original dollar doesn’t come back to you with it’s profit margin attached in a reasonable time…and seriously dangerous if it comes back late with no profit margin attached at all!
One of the built-in laws of business that gives us all so much joy is that the outward stream of cash is pretty consistent, and it’s been under the microscope for so long anyway there’s not much available scope for managers to alter it…
So when new working capital availability is tight, and banks and principals do not want to, or cannot, provide more, even restrained outgoing cash causes a squeeze very quickly.
Reserves that were set aside are used up in a blinding flash…it becomes very hard to make loan payments, purchases are limited to desperate essentials, creditors get delayed even more than usual, tax payments are not made, and principals become very scratchy because they can’t get any drawings beyond salary in the early stages, and even that dries up in due course, usually initially so staff can be paid on time…
In trying to make sure that the continuing working capital you need is there from the operations of the firm itself, what sorts of things go wrong most often?
• Firms allow the time it takes to get paid by clients to blow out once bills have been rendered…
Obviously this means you do not have available to you the same cash you would have if everyone paid on time or at least only as late as they were paying previously!
• Firms do not bill every matter at the earliest possible time commensurate with the arrangements they have with the client…
Unbilled Work In Progress is unnecessarily high and it’s average age increases…holding working capital in “suspense”, tied up in files without clients even being asked to pay!
• File velocity drops on the work in hand, so you do not reach the points where arrangements might allow you to bill clients…
Even when the human resources engaged in the matters are diligent, a workload that is too big for the allocated resources will cause a slowing in file velocity, again meaning matters take longer to reach a point where a bill can be rendered…
• Fee-earners simply do not have enough productive client file work to do, so even if diligent about what they do have, cannot produce enough fees to meet their KMSWorkPlan™, and will thus generate far less than the planned margin on your costs of having them on the team…
• Disbursements are incurred without funds in from Clients to cover them, in situations where that makes no good business sense.
Obviously there are many other key causes of cash drying up fast, but in many firms there are not even the most fundamental tools in place to identify potential problems early enough.
For example, far too many files may be commenced where your ability to get paid in full on time is not protected. Work is done, often very large volumes of work, where you may never get paid. These jobs suck out of the firm much of the profit margin on your “normal” jobs, and may well mean that the employee(s) involved are a large net drain on your financial resources rather than a healthy contributor to profit and cashflow.
Fee-earners regularly fail to bill every matter they are entitled to at the earliest possible time…they simply do not get around to it, and usually can trundle out every “reasonable” excuse in the book…but of course expect to get paid for every day that elapses… while their properly accountable team members are doing what it takes to try to keep working capital moving and the firm soundly afloat.
The simple acid test for all unbilled Work In Progress must be applied and monitored at least once a month…Bill it now? Hold it to bill later with good reason? Write it off now with good reason?
If someone with experience applies the acid test to all unbilled WIP of every fee-earner much will be learned about the way work is being done on those files, and again, early action can be taken to prevent more waste and future serious bleeding.
All too often, the inability to bill large slabs of WIP is not discovered until after a team member leaves. A once-a-month proper analysis is far more effective in weeding out problems.
People sometimes take on far too much client work without a proper appreciation of what the resulting reduction in file velocity does to cashflow. The velocity of all Work In Progress must be monitored closely and causes of deterioration scrutinised so effective solutions can be found early.
In the majority of situations cashflow problems are caused by people not doing the right thing, and exascerbated by management taking its eye off the ball.
Managing lawyers is a difficult skill, made more difficult by managers not engaging lawyers enough in understanding the essential, non-negotiable, behaviours required of a thoroughly competent professional.
Too much leeway is given, usually born out of a desire to avoid confrontation, and there is far too much surprise expressed when people let the team down in a big way.
The lesson is there for the learning. In most businesses the gap between financial “happiness” and financial “misery” is very small indeed, and leaving team members alone to try and get it right, without strong non-negotiable guidelines, is a pathway to serious unhappiness.
Rob Knowsley LL.B MIMC
Knowsley Management Services
6 December 2011
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