Fundamentals of strong cash flow in law firms

In late 2011 I posted about why law firm cash so often dries up so quickly, and made the strong point that with law firm profit margins being so slim after proper principal's salaries, management must get the fundamentals right to avoid a crisis in availability of working capital.... Where does all the cash go? 3 December 2011

All too often I encounter law firms focussing only on the short term, after-the-event, aspects of cash flow management.

Typically they are engaged in a stressful juggling act, holding off payments as long as possible, chasing debtors, pursuing staff over bills that should have gone out, desperately anxious for funds to come in to get them through another week...

In the worst situations, managers have become despondent, and tend to blame many factors that may well be at play in a minor way, but are certainly not the root causes of the present cash flow problems...

In the most simplistic analysis, firms invest wages and associated costs, and all other overheads (including principals' reasonable base salaries), in a fairly simple operation to generate sufficient revenues to create a decent profit margin.

If they collect the revenues quickly enough, by billing at the earliest proper time and collecting promptly, they normally should not have a cash flow problem.

Around the edges there are ways a firm can use too much cash without a compensating injection of additional working capital, but those situations are usually not all that mysterious.

Where the problems start is right at the very beginning...in determining what amount of revenues should flow from the efforts of the people you have invested in...principals included.

Work backwards further...revenues will only come from work progressed to a point where you are entitled to bill, and get paid for, so cashflow is ultimately fundamentally dependant upon how much work you get done from the overheads invested in any given period...

This is where the 'fun" begins!

Most small-medium law firms do not organise to get enough work done...they set the goals too low, and all the surveys show that most firms then proceed to fail to achieve even those inappropriately low revenue targets...

The 'normal'  narrowness of the potential margins is thus pared down even further in the dim dark recesses of the firm where the basic rules are set, or not set, and the tightness of future cash is pre-destined by the behaviour of managers, usually principals.

Why does this happen?

In my experience it's because managers do not realise just how important it is...they pay lip-service to it. Even when they do try to get the numbers up they actually do not know how to go about it...their lack of people-management skills comes fully to the fore.

Often they console, or even pride, themselves with being "good bosses", pretty easy-going, and running an enjoyable firm to work in, little realising that this is in fact at the heart of all their cash flow problems.

There is insufficient balance between being a nice boss to work for and running a tight ship financially...

The reality is that it is perfectly possible to have staff working a full day for a full day's pay, without being an awful boss to work for...

Next time you have a cash flow crisis can I suggest by all means deal with the short term fixes first, but then move on to a deep and careful analysis of whether you really do have adequate margins built into your planning.

The most important area to look at is whether your staff who do legal work are, where appropriate, doing legal work for most of the hours each day that they are paid for. It's a myth that most fee-earners need large amounts of time each day to do other FirmTime things...only some people do!