Breaking the Link

Lawyers are obsessed with measuring profit. Over an extended period profit and cash flow are related, but our workshop feedback shows that many lawyers do not fully understand the link between the two.

Successful firms can create a strong positive cash flow. They may choose to reinvest it in growth, and use up the cash, but that’s another matter. They do generate the cash. Conversely unsuccessful firms spend more than they earn and burn cash (or liquidate their assets).

But we are currently in very confusing times especially for law firms-one client called it a Fools’ Paradise. Many firms at the moment are experiencing poor trading conditions and (especially if they account for Work in Progress movement in their monthly accounts) have much reduced profits.

Income is down, partly but not fully offset as staff costs are reduced by Furlough and some salary reductions-and yet cash flow is strong.

 

There are two reasons for this

 

Firstly cash flows come in from prior billing-March and even April were good for many firms. Secondly the government has broken the link between profit and cash flow. Firms are being allowed to keep the VAT they collect on billings, but are not being required to pass it on to HMRC until next spring. Similarly the Partners Tax liabilities on profits already made are also not to be passed on to HMRC until next January. This has helped many businesses, not just law firms, to continue to trade through this unprofitable period.

But-the liabilities are not cancelled, only deferred. HMRC still needs to be paid. The link between profit and cash flow will be re-established at some point. Make sure that you have a robust cash flow forecast, and ideally have some reserve pots holding onto the cash that HMRC will eventually ask for