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Cash Flow Drought: How to Identify and Deal with It
Have you ever heard the term “cash is king”? This refers to the importance of cash flow in the overall fiscal health of a business. For small and solo law firms, cash flow is the lifeblood of running the firm. Positive cash flow allows you to:
- Have psychological peace of mind;
- Focus on practicing law and operating efficiently;
- Obtain discounts from vendors and gain purchasing power;
- Be in a position of strength when settling outstanding invoices due;
- Earn excellent credit ratings from financial institutions to establish lines of credit; and
- Create flexibility in making business decisions.
Cash flow management in small and solo law firms can be particularly challenging. You need to account for the time lag between cash going out and cash coming in. This requires financial and management discipline, strong internal policies and procedures for billing and collection policies, planning and attention to detail.
Most lawyers just want to practice law. While in law school, lawyers never thought they would have to be the CEO of their own practice requiring them to undertake accounting and administrative tasks. Hey, you are running a business!
What Creates the Cash Flow Drought?
It doesn't take much in a professional service business to hit a cash flow drought. The following are a few factors that may contribute to cash flow drying up:
- Poor billing practices — significant accumulation of time before a client is invoiced;
- Out-of-pocket costs (client advances) are due before being invoiced and collected from the client;
- Firm overhead such as rent and insurance are due monthly while payroll may be due every week or every other week;
- Poor internal structure and lack of discipline for accumulating time and getting invoices out in a timely fashion;
- No structure for collection of outstanding invoices;
- No policy or enforcement for retainers and replenishment of retainers;
- Repayment of loans or lease commitment payments and;
- Acquisition of equipment or other assets.
There are common themes seen when a cash flow drought is experienced: poor firm culture, lack of discipline, poor organizational skills, little structure and no consistency in applying policies.
Strategies
The solution is to be proactive. There are several strategies that you can implement to prevent a cash flow drought from occurring and will hopefully enable you to accumulate that rainy day fund.
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