Profit is Vanity. Cash is Oxygen. Why Cash Generation Matters More than Ever.
Law firms have traditionally been obsessed by short-term profitability considerations to the detriment of long-term investment. Law firms are different from most other mature commercial sectors in two material respects.
First, law firms, unlike other commercial organizations, tend to distribute or allocate the entire profit of their firm to shareholders every year.
“Law firms can be very profitable but many are short of cash.”
Second, most commercial organizations in other sectors judge their performance, at least in part, on the concept of ‘shareholder value’, whereas in most law firms, partners’ capital is fixed, with retiring and outgoing partners taking away with them only the amounts originally invested by them without any capital appreciation. While this historical model continues to find favour with traditional law firms, it does not suit firms where outside investment is needed, as external investors always look for a return on their investment in the form of an increasing income as the firm grows and expect a capital return in due course.
Investing for growth can be expensive. Even in the best run law firm, the extra working capital required in an expanding firm is often around one-third of the expected fee revenue growth from new work. This is because the investment in new fee-earners, as well as the work in progress and the amount of bills delivered but unpaid, all must be funded. In poorly managed firms this ‘lock-up’ of work done but not yet paid can be painfully high. This in turn has a knock-on effect on the firm’s borrowing need, which therefore tends to increase as the business expands. Firms then increasingly find themselves at the limits of their borrowing capacities. Whilst the levels of partner capital accounts are often very historical, it is never easy to persuade partners to increase them by capital calls or promotions.
“Many smaller firms find themselves caught in a financial vice caused by competitive forces.”
Many smaller firms nevertheless find themselves caught in a financial vice caused by competitive forces – suffering declining profits, unable to invest for either growth or consolidation, and at the limits of their borrowing capacity. Financial efficiencies and discipline can always help such firms but eventually reaches a ceiling. Hence, we see more firms are entering voluntary arrangements, merging or simply going out of business and we see this trend growing.
A good way of keeping borrowing under control in an expanding, or even static, business is to generate more cash internally.
“Sound financial management is not just about the numbers but all the non-financial elements of intellectual capital.”
The table of financial management principles illustrates the need for efficiency, discipline and performance management in the financial affairs of the law firm. It sets out ten sound management principles that I suggest firms embody. The key is to understand that sound financial management is not just about the numbers alone but all the non-financial elements of intellectual capital that affect how those numbers move and change. Indeed, good financial management can only be performed if good overall management is in place. This is why the firm’s long-term future financial performance and profitability is an important and integral part of the firm’s strategy for survival and prosperity. The implementation of any strategy ultimately depends not only on the firm’s commitment to implementation but its financial and non-financial resources and capabilities to fund and support the firm’s objectives and goals.
Ten Practical Ways to Strengthen Cash Generation
| Principle | Purpose / Practical Focus |
|---|---|
| Strengthen Profit Quality | |
| 1. Control breakeven growth | Ensure the firm’s breakeven point increases more slowly than overall fee income as the business expands, maintaining profit headroom. |
| 2. Optimise fee rates | Strengthen pricing discipline and refine fee structures to improve margins wherever the market allows. |
| 3. Eliminate unprofitable work | Redirect resources toward matters that deliver commercial or strategic value, and withdraw from consistently loss-making engagements. |
| Convert Profit into Cash | |
| 4. Accelerate billing and collection | Shorten billing cycles, enforce prompt invoicing, and improve cash recovery processes. |
| 5. Drive financial efficiency | Identify and implement cost savings, streamline internal operations, and reduce financial leakage. |
| 6. Build meaningful budgets | Create firmwide and departmental budgets that are realistic, transparent, and linked to strategic goals. |
| 7. Share financial insight | Cascade financial data, dashboards, and performance metrics across all levels to support informed decision-making. |
| 8. Maintain strong business plans | Require each department or group to maintain a clear, measurable, and regularly reviewed business plan. |
| Protect the Oxygen Supply | |
| 9. Monitor partner drawings | Continuously review current-year drawings to align distributions with financial performance and liquidity. |
| 10. Protect working capital through retained profits | Manage partner expectations around cash draw-downs to preserve reserves and safeguard the firm’s long-term stability. |
Summary
Cash generation is the foundation of long-term performance. It is important to understand that liquidity determines a firm’s ability to invest, grow, and withstand shocks. The problem is that rising costs can silently erode profitability even as revenue increases and weak billing discipline delays cash that has already been earned. What is more, excess partner drawings can starve the business of working capital and lack of financial transparency leads to slow or misaligned decisions.