There is a secret when it come to law firm cash flow. It’s so obvious that it is often overlooked. Perhaps it is exactly because it is so obvious that it is the source of so much confusion. For small firms effective cash flow management may be the single most important aspect of the business. Failure to appreciate the nature of cash flow and manage it properly undermines confidence and ultimately depletes cash reserves and bankrupts the firm.
With the fallout of the Covid-19 #lockdown only becoming apparent now, some firms report an 80% drop in fees year-on-year. With so much less cash flowing into the business, with expenses typically remaining constant, accurate and up to date cash flow management is critical.
Management accounting supports the needs of the business. Unlike Financial Accounting which follows strict rules based on international standards such as GAAP and IFRS, management accounting should be customized to meet the internal needs of the law firm. Although details may differ, management accounting reports should support decision making and inform planning, operations, performance measurement and alert when intervention becomes necessary.
Unsurprisingly there are several management accounting reports which are commonly used. Cash Flow statements are routine for any business. They have their place alongside Budgets and Cash Flow Forecasts. To make it easy, think of it like this: a Budget is a plan on how to spend money. A Forecast is how much money we plan to earn. And of course the Cash Flow Statement shows where all that money came from, and where it went. In a perfect world the forecast, statement and budget should line up.
A report on cash flow differs from a formal Income & Expense account in the sense that it does not follow the formal rules of Financial Accounting, but more importantly, it deals with cold hard cash, and where it went. Income and Expense are book entries and serve a formal, specific purpose, often removed in time from the actual cash transaction. A cash flow statement is all about money in, money out.
A basic report on cash flow should cover at least the following elements
- cash on hand
- cash received
- cash spent
- cash remaining
Generally cash spent should be in line with the Budget. Eventually the cash remaining will amount to profit, but that’s a different story.
If cash spent exceeds cash received, our expenses exceed our income. If this situation goes on uncontrolled all operational cash will disappear and instead of profit, a loss results.
With law firms, it is important to understand and distinguish the nature of cash received.
Lawyers pay for certain services on behalf of their clients. Money paid to an advocate, or sheriff must be recovered from the client. But, here is the secret, those disbursements refunded, or reimbursable expenses recovered, do not represent free cash.
Consider cash received where a substantial portion represents a disbursement recovered. Think of it this way: that cash is simply the money coming in, on a previous out. The law firm breaks even, there is no free cash to spend.
For a law firm, effective cash flow reporting should be extended:
- cash on hand
- cash received for disbursements (refund in)
- cash received from fees (in)
- cash previously spent on behalf of client (disbursement out)
- free cash to spend on expenses
- cash remaining
There are risks hidden in poor cash flow. Where disbursements are not recovered aggressively cash generated by fees must be applied to cover the disbursement. VAT on disbursements become payable regardless of the recovery thereof.
By clearly distinguishing the nature of the cash in (free or refund) it is easy see exactly what is available to spend on expenses. Modern, cloud based accounting systems make it easy to accurately distinguish various ledger account types involved (such as client trust, current liability, expense etc) and enforce a strict processing model in order to distinguish fee income from disbursements paid.
Imagine looking at an ordinary trust to business transfer report and being able to identify each client account, and the amount on each, transferred as free cash and which amount merely a refund.
For more information on how Dynamic can boost your cash flow, with a Trust to Business Analyzed Transfer and other management tools, simply scan the QR tag with your phone. Another secret, that QR tag is an entire business card, with telephone, email and website.
