Using the Right Financial Metrics to Predict Future Cashflow

This article first appeared in Managing Partner for August 2012 and is reproduced with their permission

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, financial and economic management is a core competence for any law firm leader. The late summer and early autumn is never a good time for positive cash flow. 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 which have already happened. A prediction is not a fact – yet. Hence lawyers are somewhat better at looking at past performance than in predicting the future. The mountains of financial data available in law firms reflect this. Management information and performance yardstciks are drawn from the firm’s systems and are mainly lagging indicators. It is very easy for firms to get trapped into continuing to monitor what they have always monitored. Law firms have become very accustomed to sifting through a proliferation of data and measurements which flow from their time and billing systems. Predictors of future performance and cash flow 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 which may have been set several months previously. Budgets, however, rarely act as accurate prophecies of future performance.
Some partners also get obsessed with the wrong type of measurements. The firm’s position in the league tables, its growth and relative size in terms of revenues, people and offices may be interesting but they are often not totally relevant to the firm’s future cash flow and profitability

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

In trying to balance the firm’s cash and profitability needs, there are three areas on which Managing Partners can focus

1. Work out a set of measurable leading indicators to assist future planning and predictions. The work includes include
• Methods of analysing levels of present activity and utilisation which give a guide as to future cash flow
• 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
• Better capture of engagement fee estimates in a form which can provide measurable predictions

2. Hold Practice Group Leaders to account regularly to report, not just on past performance, but on likely outcomes for the remainder of the financial year (or even just next month), including
• Financial Predictions including likely levels of utilisations and predicted revenues for the next period (where likely to vary from budget)
• Predictions and cash flow timelines for 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,
• Information on successful (and unsuccessful) proposals, including rate discounts conceded
3. The Managing Partner should also gain insights on future trends including
• Maintaining an interest in the macro-economic scene through a variety of reading and media watches
• Obtaining 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
• Informal feedback from other professionals – accountants, estate agents, private equity houses and the like – 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 spread-sheet but is a product of the careful and holistic management of the practice and its people by the firm’s leaders. Even when the three listed areas of focus prove to be depressing and somewhat pessimistic, early diagnosis can help Managing Partners both to manage expectations and to galvanise partners out of any sense of temporary complacency to plan realistically for a difficult period