Any business requires a steady flow of cash in order to continue functioning successfully. This applies equally to companies both large and small, cutting across all industries including law firms. While this basic principle may seem self-evident, it was one of the main reasons for the dot com crash in the 1990’s and remains a catalyst for why many small businesses get into trouble.
Cash flow is not the same thing as revenue or even profits. While the later provide an accounting view of the profitability of a law firm, only cash flow tells you how much money is in the bank at the end of each month.
As the old saying goes – ‘revenue is vanity, profit is sanity, but cash is king’.
The law firm cash gap
Legal practices generate profits by charging clients fees for legal services rendered. While cash moves in and out of a law firm, the difference in timing between when you pay your expenses and when clients eventually pay you can be significant.
Cash inflow from a law firm’s clients always seem to play catch-up with the cash outflow of business operations. In fact, firms often pay wages and other expenses before the invoices have even been even sent. Any disruption in the smooth payment process puts a lot of pressure on this tenuous system.
The Cash Gap in a legal practice is defined as the difference in time from when salaries and other overheads are paid for legal work until the invoice has been settled by the client. Well run firms constantly work to shorten the cash gap as far as possible to reduce the cash strain.
An interview with Elad Smadja, Head of Financial Operations, Taurus Capital, and Dr Ivor Blumenthal, CEO, ArkKonsult, discussing how a steady flow of cash is required in order to continue functioning successfully and that this applies equally to companies both large and small, cutting across all industries including law firms.
Only by having a defined measure of a law firm’s cash gap, can the managing partner successfully manage the liquidity of the firm. As management guru Peter Drucker says: “You can’t manage what you can’t measure”.
|CASH GAP – The difference in time from when salaries and other overheads are paid until the invoice has been settled by the client|
Historically the Cash Gap for law firms has been about 105 days. Clients typically settle their accounts in 60 – 90 days, while overheads are paid within 30 days (see figure 1.1). However, this can be much larger depending on the areas of law practiced by the firm.
For example, an attorney who litigates personal injury claims on a contingency basis may need to carry the cost of overheads and disbursements (advocate fees, medical expert reports, actuarial loss of income reports, etc) for many months or even years before…
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Read the full article by Elad Smadja, Head of Financial Operations, Taurus Capital, as well as a host of other topical management articles written by professionals, consultants and academics in the October/November 2019 edition of BusinessBrief.
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