The recent economic slow down, coupled with the “credit crunch”, is putting the cash flows of many firms under great strain and some firms are at breaking point. Some commentators have estimated that perhaps 10% of firms are now in real trouble and are being closely monitored by banks. If this is true then there will be many more firms who could easily slip into trouble if they do not actively manage their cash.

So where does the cash that firms must have in order to continue to trade come from? There are two traditional sources, being from the partners’ own resources and from banks. In the current climate partners might struggle to raise additional cash as this would often be raised by taking on a mortgage against their house. With the mortgage market being fairly frozen this source of financing may be difficult to raise. The other way in which partners might try to inject fresh capital into the firm is by retaining profits earned rather than distributing them. This may be realistic in good times but when profits are falling partners find it difficult to retain profit as they need to take out a certain amount of cash from the business to meet their personal spending needs.

The alternative source of funding is obviously from the banks, but given the recent meltdown of the balance sheets of some of the larger banks, it is doubtful whether they have the desire or the funds to lend more to law firms. Indeed, it would appear that banks no longer see law firms as quite as safe they once were. If money is obtained from banks it is important to ensure that there is an appropriate mix of term loans and overdraft finance, since if all of the borrowing is in the form of overdraft finance it gives the bank great power over a firm if there are short term cash flow problems. How much should a firm borrow to finance the business? This will depend on the risk that partners are willing to take but there are some simple rules of thumb. To borrow up to 50% of what partners contribute is cautious but professional people do not like to borrow in the first place. Traditionally, banks would probably have been happy to match the capital contributed by partners in some form of lending but once this position is exceeded questions should be asked about whether more partner capital is required.

It is clear that the cash resources of some firms are currently being stretched to the limit. It is therefore more important than ever to be focused within the firm on the collection of cash with more cash on account, tighter control of billing patterns and improved credit control. In the market place today, the firms with cash have real power.

© Robert Mowbray - Partner with Taylor Mowbray LLP

January 2009

Taylor Mowbray LLP
rmowbray@taylormowbray.com

Telephone: 07979 517221