Interpreting your firm’s financial data – can you do it?
The SRA is looking increasingly at the financial stability of firms. Have you taken a look at your financials recently to see how you are doing? More to the point, do you know what you are looking for and how to interpret the information provided?
So what are the financial issues that legal businesses should be focusing on?
It is easy to overcomplicate the finances of a law firm when the reality is that it is a very simple business. There are really just two issues that need to be monitored and managed as follows:-
- The short term issue – cash flow
- The long term issue – profitability
Law firms must always have enough cash day to day to pay liabilities as and when they fall due. However, over a longer period of time they are trying to maximise profits. Making more profit can damage the cash flow in the short term as you might need to spend first on marketing, new fee earners and new systems before later on you receive more cash from a growing portfolio of clients which eventually fuels higher profit.
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What needs to be looked at to ensure that both issues are under control?
The key document for controlling cash flow is the cash flow forecast. This should be prepared monthly for the following six month period. It is designed to predict the cash flows over that period so that you can predict your bank balance over the period and see the likely peaks and troughs in your bank balance over the period.
Once prepared, you can check that you have sufficient finance in place to survive the period and you can make arrangements to deposit surplus cash as and when it will arise to give you a greater overall profit.
Turning to the longer term issue of profitability, to get an understanding of how you are performing requires a review of the profit and loss account. This shows your income for the period less the direct cost of your fee earners to give you a gross profit and then your overheads are deducted to arrive at the net profit. It is the gross profit level where you should place most attention. The business is buying the time of fee earners through the payroll and trying to sell that time at a profit to clients. How successful your firm is at this will determine the level of gross profit earned. You need to earn sufficient gross profit to cover your overheads which tend to be more fixed amounts.
It is the relationship between fees earned and fee earner salary costs that is key as this demonstrates the productivity of your fee earners. Fees at a multiple of three times salary costs is often used for budgeting purposes and is seen as a good level of productivity. Most firms only achieve two or two and a half times salary costs as a multiple. As a consequence, the gross profit is lower and so is the bottom line profit after the deduction of the fixed overheads. Effort invested in improving productivity will pay dividends.
Given that time and effort goes in to creating your financials, you should at least take some time to understand them and to use them to help you to run a more successful and secure business.