May 23, 2006
Cash Is an Unreliable Barometer of Law Firm Health
I often talk about law firms that are accidentally successful. That is a term I borrowed from Debbie Foster, president of Intouch Legal. At least Debbie is the first person I know that used the term.
Accidentally successful law firms are running on autopilot. As long as there is money in the bank account, everything must be okay. The trouble is the bank account is a lagging indicator for a law firm. When it goes amiss, it is usually too late to do anything about the problem. Consider the following graphic:
For the average law firm, there is a 4 ½-month lag between the time billable services are rendered and the date that the client’s check gets deposited in the law firm’s bank account. The above simple graphic doesn’t tell the whole story. The pipe has holes in it. “Would be” cash leaks through those pipe holes as write-offs, adjustments, and bad debts. The longer the pipe, the more "would be" cash is wasted.
Given the lag time, a train wreck can be just ahead and the accidentally successful law firm will not have a hint that it’s coming. The partners will miss the opportunity to take corrective action. They will miss the opportunity to take steps to reduce costs or secure access to additional funds. In short, 4 ½ months after the cause, they wake up and find the coffers empty.
Neither unbilled fees nor fees receivable appear on the typical Cash basis balance sheet of mid-sized firms. But it is essential that they be tracked and managed.
That is not enough. You need to take another important step. To avoid the perils of an accidentally successful law firm, managing partners need a forward-looking system that forecasts cash flow months into the future. The key to a workable forecast is not to get too complex. A law firm is a relatively simple business, and if you understand your particular firm’s key operating metrics, building a workable model is not too difficult. It is important to update your forecast monthly.
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Filed under Cash Flow Issues, Management by Tom Collins