Partners focused on doing ‘the work’ often take their eye off the lifeblood of their business; cashflow.
Without cashflow, the firm struggle to pay debts and pay you, the owner. Managing cashflow and driving cashflow improvement is just as vital to a law firm as a clear revenue strategy. You cannot afford to ignore cashflow management.
The Cash Gap
There is a difference between profit and cash. Take a look at the following diagram.
In this example, the time between the client agreeing to the engagement and receiving the cash is 105 days.
However, the final profit is recorded 60 days after the engagement. You have 60 days of expenses of which the majority are not on credit (wages, rent, interest, IT leasing).
The fundamental focus of any profit and cash flow plan is to ensure that the time between receiving the cash and signing the costs agreement is kept to a minimum. You might think this is impossible but there are plenty of businesses that do it.
Think about the following. If you build a house, does the builder require a deposit when you sign the contract? When you buy a new pair of shoes do you have to pay for them before you leave the shop? If you go on a holiday, do you have to purchase your plane tickets before you get on the plane? Most successful businesses bring this gap between sale and cash receipt back to the bare minimum, and doing so means improved cash flow. This is called the cash gap (the time between signing the costs agreement and cash receipt).
The cashflow improvement formula for a healthy business should:
1. Drive WIP down
2. Drive debtors down
3. Maintain creditors at terms
So that surplus cash exists to:
1. Make asset purchases
2. Pay debts
3. Pay dividends and drawings to partners
Managing cashflow by focusing your strategies on these areas will give you confidence in the business decisions you make.
The key formulas and KPI’s for managing your cashflow are:
Using current year revenue of $5,000,000, a cashflow improvement of $160, 000 can be achieved by a 10% improvement in WIP and debtors days. A 20% improvement will result in $320, 000 of cashflow improvement, as shown below:
In summary, the Top 5 Cashflow Strategies for your legal firm to drive cashflow growth are:
1. Plain English Cover Letter
You need to make sure your clients fully and completely understand the terms of doing business with you. Your cost agreement is a legal document that is required under the Legal Practitioners Act. To drive cashflow improvement, you must make sure that your clients are clear on the following:
1. An estimate of what you will fee them.
2. The timing of billing.
3. The payment terms and methods.
By signing off on this, your client effectively gives you permission to follow it in terms of your cashflow procedure. The more they understand, the greater your cashflow will improve. This is the first step to reducing the cash gap.
2. Initial Fee at Signing
You should bill your clients at least one third to 50% of your estimate at the time of signing the agreement. This doesn’t mean that they have to pay you before you start, or put the money in the trust account, it just means your terms of engagement are that you will bill an amount at the start. It will be payable by the client on the normal payment terms as stipulated in your costs agreement. This is the 2nd step in reducing the cash gap.
3. Deposit Cash into Trust Account
You will only be entitled to bank cash received into your general account if you have done the work. So when you receive your client money, deposit it into your trust account and move to step 4.
4. Minimum Weekly Trust Account Withdrawl
Now that you have the cash in the trust account, review the WIP balances at least weekly to determine the extent of your cash withdrawals to your general account.
5. Minimum Weekly Debtor Follow Up
Be ruthless about following up your outstanding debtors. The client has agreed to your terms in the cost agreement so hold them accountable to follow your payment rules.
By using the example above, if you bill your clients 50% at the commencement and the balance on completion and assuming they pay on 30 days the cash gap would reduce from 105 days to:
– the first 50% to 30 days
– the last 50% to 90 days
Think about the cashflow improvement in total dollars for your firm.
To review your current profit and cashflow strategies and determine what is possible in terms of growth from your firm, call Matt Schlyder on 07 3833 3999.