Running a solo practice or small law firm is like running any small business in most ways. Take out the Rules of Professional Responsibility and it’s not that much different from running a plumbing company.
I should know. I’m a small business lawyer, and I advise other lawyers regarding running a business.
One thing that is hard to teach all small business owners, including lawyers, is how to manage cash flow. Cash flow is simply the movement of cash into and/or out of a business. Lawyers look at cash flow to evaluate a few different things, including, for example:
- The profitability of any particular practice area, business activity or project or even the firm as a whole ;
- The firm’s overall rate of return or value;
- Problems with a firm’s liquidity; or
- The financial risks associated with a new practice area.
The operating cash flow of a law firm can be calculated as the change in cash balance over a given time period – a day, a week, a month, or a year, even hour by hour – as a result of the firm’s day-to-day business activities. Cash flow is said to be positive if the cash balance increases, and negative if the cash balance decreases. Operating cash flow must be net positive if the firm is going to stay in business.
You have to know what your cash flow is, every single day, or you could lose your firm. But constantly keeping up with what’s coming in and what’s going out can make you crazy. And no one can do it for you. No matter what accounting software you use or what bookkeeper you hire, it is your responsibility as the owner of the business to know your cash flow situation on an ongoing basis.
But we didn’t go to law school to become accountants, did we?
So I teach my clients a very simple, old school method of calculating their cash flow. It’s the one my mother taught me when I was a kid, and it’s the one I use today.
Mom was an Army wife. On a Seargeant’s salary, my mother managed to provide for four kids, pay off mortgages and car loans early, sent herself to nursing school, and saved for our college educations. At 77, she can tell you her current cash situation off the top of her head at any point in time.
She does this by keeping a running total of what cash has actually come in less any expenses that have been paid, whether the checks have cleared the bank or not. While Mom can keep up with it all in her head, I use my bank’s online balance feature and the ledger in my firm’s checkbook to do it. Money in minus money out. It really is that simple to keep up with your current cash flow on a rolling basis. And it’s just that difficult.
I also use accounting software. Since I’m a Mac user, and I really am not a fan of Quickbooks for Mac, I went with Corona, a great little double-entry accounting system with payroll functionality built in that costs a mere $60. It works for me, and I get some nice reports that let me monitor cash flow over the long haul.
If your cash out exceeds your income, your cash flow is negative, and you are in trouble. This fact is hard for many lawyers to grasp because they too often equate financial success with hours billed out rather than cash realized in. For that reason alone, our profession’s obsession with hourly billing confounds me. If you bill $150,000 a year, but only collect $75,000, chances are you aren’t being profitable. Unless you keep a close eye on your cash flow, you are likely to spend based on your billing, not your actual cash receipts.
Moreover, in my experience, if you can tell a client how much your services will cost, you more than double your chances of collecting for your services up front. That not only improves your cash flow, it improves your efficiency (because you aren’t having to make collections calls) and your profitability. Not too shabby.
Some examples of how I have used cash flow to monitor and grow my business:
- I used the reports from my accounting system to monitor my cash flow on a month-to-month basis for the last six months. I knew that I could afford to move out of my home office and into a “regular” office because I could see that my firm was profitable over that period, and, more importantly, that it was growing in profitability to the point that I could afford the higher bills and make payroll and still turn a profit.
- I increased staffing when I saw that hiring a part-time file clerk would reduce the time I spent on unprofitable activities like filing, scanning and shredding. Hiring a law clerk to handle basic research has freed up additional time to spend on more profitable activities. On my cash flow reports, I can see that for every dollar spent on payroll, my firm earns between $1.50 to $3.00.
- Because I know exactly what cash has come in and what bills and expenses I have outstanding, I know what, at a minimum, I have to bring in for receivables on a weekly and monthly basis. These are not made-up numbers based on a budget I invented; these are cold hard numbers that tell me how healthy my business is.
- I recently raised my basic flat rates for certain services after I analyzed the cash flow regarding the cost of providing the services and the revenue they generated, and determined that the services were costing almost as much as I was charging. I was able to adjust my fees to make these activities profitable without gouging my clients.
Know your cash flow. Know if you have the liquidity to buy that overpriced legal treatise or whether you need to visit the local law school library. Know whether your investment in your employees is paying off. Know that you really are (or are not) profitable.
All opinions, advice, and experiences of guest bloggers/columnists are those of the author and do not necessarily reflect the opinions, practices or experiences of Solo Practice University®.