Are you using the right financial metrics to predict future cashflow?

By Nick Jarrett-Kerr, Visiting Professor, Nottingham Law School 

This is my first regular Managing Partner column on the challenges facing law firm leaders. In the coming year, I will consider the main issues that keep them awake at night and suggest strategies to aid better sleep.

One of the critical tasks for any managing partner is to manage the firm’s cash and profitability on both a short term and long term basis, aided in most cases by an able finance director.

The late summer and early autumn is never a good time for positive cashflow. The distractions of holidays and the consequent drop in transactional activity often provide a tricky juggling act between incoming and outgoing cash requirements.

Lawyers deal mostly with facts and data, which are largely products of the past and incidents that have already happened. A prediction is not a fact – yet. Hence, lawyers are somewhat better at looking at past performance than they '¨are at predicting the future. The mountains of financial data available in law firms reflect this.

Law firms have become very accustomed to sifting through a proliferation of data and measurements that flow from their time and billing systems. Predictors of future performance and cashflow are harder to come by.

The firm’s set of agreed financial targets can help, of course, and most firms will assess actual performance against a budget that may have been set several months previously. Budgets, however, rarely act as accurate prophecies of future performance.

One task that cannot be left to the finance staff (however capable) is to refine all of the possible indicators from what might be an impossibly long list of prospective metrics into a manageable quantity that are business critical, indicate whether the firm is travelling in the right direction, and drive behaviours and future performance.

In trying to balance the firm’s cash and profitability needs, there are three areas in which managing partners should focus.

1. Work out a set of measurable leading indicators to assist future planning and predictions. This should include:'¨

• methods of analysing levels of present activity and utilisation, which give a guide as to future cashflow;

• monitoring the amount and value of new work, including repeat instructions from key clients;

• from a short-term point of view, measuring work-in-progress which will shortly convert to cash; and

• better capture of engagement fee estimates in a form that can provide measurable predictions.

2. Hold practice group leaders to account regularly to report not just on past performance but also on likely outcomes for the remainder of the financial year (or even the next month), including:'¨

• financial predictions, such as likely levels of utilisation and predicted revenues for the next period (where likely to vary from budget);

• predictions and cashflow timelines for the conversion of accounts receivable and work-in-progress into cash;

• work pipelines;

• engagement reports;

• data on staff turnover and '¨activity levels;

• information on successful (and unsuccessful) proposals, including rate discounts conceded;

• business development and marketing activities undertaken last month and planned this month;

• major client feedback points about the state of the market and likely activity;

• possible cross-selling activities;

• client-focused marketing activities;

• client and staff feedback about the state of the market and likely activity;

• data on staff turnover and activity levels; and

• information on successful (and unsuccessful) proposals, including rate discounts conceded.

3. Gain insights on future trends. This should include:'¨

• information on the macroeconomic scene through a variety of reading and media channels;

• client feedback on their likely activity and the issues that are keeping them awake at night;

• partner and staff feedback on the state of the market;

• professional and support staff observations and feedback; and

• informal feedback from other professionals (such as accountants, and private equity houses) that give clues about the level of work likely to come down the chain to the law firm.

There is some truth in the old adages that you can only manage what you can measure and that people are best managed one at a time. Cashflow forecasting is not just a set of figures '¨on a spreadsheet, but also a product '¨of the careful and holistic management '¨of the practice and its people by the '¨firm’s leaders.

Even if the three listed areas of '¨focus prove to be depressing and somewhat pessimistic, early diagnosis '¨can help managing partners to both manage expectations and galvanise partners out of any sense of temporary complacency to plan realistically for a difficult period.

nick@jarrett-kerr.com