As we reach the mid-point of the calendar year, law firms should be evaluating key financial metrics. It’s a great time to begin tax planning for the full year and to preview next year’s tax returns. Starting now gives owners time to adjust if too much or too little has been withheld. It also allows leaders to take stock of projected cash flow and expenses.
There’s one element to which firms should pay particular attention this year: cash reserves. Many are in the habit of distributing all profits to partners or shareholders at year’s end, but this means they have no cash on hand when January 1st rolls around. The legal press has finally gotten around to questioning the wisdom of draining cash reserves every year. This is a dubious strategy generally (as we wrote about back in 2015), but it could be ruinous in 2020.
Right now, the risk of a financial shock is significantly higher than usual. Employees could get sick, clients could be unable to pay their invoices, and hackers could take advantage of the vulnerabilities of a work-from-home system. The government is rapidly changing rules and requirements, which makes it difficult to plan, and a firm’s other sources of revenue, like subletting office space, are much less reliable.
Beyond the safety net that cash reserves provide, law firms can use cash to expand through acquisitions of distressed firms. There will be more disgruntled but talented lawyers on the market over the next 6-9 months. And with interest rates as low as they are, now could be the perfect time to grow your firm’s market share. These are all better potential uses of firm profits than dividing them among the owners.
Because of the dip in revenues that generally accompanies the holidays in the last quarter, firms should work with their accountants now to plan toward ending the year with cash reserves to cover, at minimum, two months’ worth of expenses.