Here’s One Key Reason Why Financial Health, Critical for a Small Law Firm and its Owners, is Very Often Systemically at Risk…

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There are lots of ways to tell if a small law firm is financially unhealthy, but one that is all-too-often ignored is when the practice can’t pay its working owners a commercial remuneration.

It’s vital that this all-important “expense” is budgeted for, built into cash flows, and actually paid on time in the same way other “employees” are supposed to be!

If those sensible business steps are taken the owners will get very large red flags if liquidity is not going to be adequate to pay all key resources their remuneration.

Building the commercial remuneration and benefits (not anticipated profit shares) of working owners into the normal budget will push up expenses as a share of revenue by quite a few percentage points, and reduce the genuine profit being budgeted for (more on this below).

With a properly prepared budget completed well in advance of the new Financial Year a firm has the maximum time to react effectively to the first red flag, so that all the necessary changes are implemented early enough to optimise the likelihood of avoiding critical liquidity issues later…issues that would have been apparent to the eye of an experienced “red flag expert” from the outset.

The red flags…

·????? What is the properly prepared budget forecasting as a genuine owner profit? If not reasonable, what needs to be done to change strategy and operations so it is?

·????? The gap between file numbers needed monthly at known average fees and the level of files being opened.

·????? The cash flow (reviewed at least monthly) is indicating when not all expenses can be met on time, including owner compensation (forget profit share…there may well be none if key things don’t change fast)!

·????? Bank will meet the payroll for employees this pay cycle, but not for all “employees” …working owners need to wait. Often this scenario also involves the firm not being able to make payments to tax authorities for one or more of employee tax deductions, compulsory superannuation, GST, Income Tax, Payroll Tax (or payment plan instalments of one or more of these).

It’s not too long a bow to draw to say that if a number of key productive resources (engaged both on legal work and in FirmTime? responsibilities) can’t be paid their proper remuneration on time the business is, or close to, trading while insolvent.

In a typical firm budget I looked at recently “profit” was forecast at 21% of revenue, without owners’ commercial remuneration included in expenses (actually or even notionally).

When I made the necessary adjustment to rectify the planning error the true profit forecast dropped to under 15% of revenue.

N.B. I only added in base salary, making no provision for this purpose for superannuation or any of the other benefits that most employees can take for granted.

Here’s the rub on revenue/expenses and profit…Guess what? Even in a well-structured and well-run firm, a 10% failure on revenue projections would wipe out around 33% of forecast profit. It doesn’t take a 3 times greater failure on revenue to get rid of all real profit…just 5% more will do it!

“Marry” that to say a 3% blowout in expenses…and a very clear pathway to zero true profit is evident.

What’s the strategy that justifies choosing to run the practice at a loss?

The margins are tight…much tighter than most appreciate, so running the tricky small business that a small legal practice undoubtedly is needs to be done in a very businesslike manner…consistently.

Apparently quite small decisions can have very large consequences for true profitability, and therefore for:

·????? Liquidity…

·????? Level of debt…

·????? Owner stress and ongoing overall wellness…

·????? Viability…

·????? Ability of owners to build reasonable financial strength for themselves/family.

·????? Practice value on succession…

Robservation…Very few small law firms “fail to achieve budget” on expenses…they always seem to creep up a bit, despite many elective spends that should be being invested in not happening, ironically often due to liquidity problems.

The Bottom-line…

In planning the budget for your law firm, and operating the firm day-to-day, treat your working owners at least as well as you know you need to treat your employees.

If doing that indicates you simply cannot make a reasonable genuine profit, which is essential for practice financial health and all the intricately interwoven upsides, you can’t be viable for long unless you have a Fairy Godmother.

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