Your 'loss' might actually be a gain

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Published on 5/28/07

A solo practitioner who is a coaching client called me to talk about his finances, and was depressed because he was operating at a "loss."

The more we talked, it was apparent that his "loss" was really an investment: he had made a substantial cash outlay for a build-out on his offices, and this had temporarily crimped his cash flow.

Because my client's receivables and collections were in good shape, I felt strongly that he was depressing himself unnecessarily. An economist would look at this expenditure in terms of its depreciation value over time; an accountant would see the advantages as a tax deduction. Neither would focus only on the short-term disadvantage of the immediate cash outlay.

My client's dilemma was a perceptual one.

There are two basic methods for tracking law firm financial performance: accrual versus cash accounting. Accrual reflects income irrespective cash collected - in other words, it includes billings, work in progress (completed but not yet billed) and accounts receivable (billed but not yet collected). Cash accounting, on the other hand, reflects only actual collections.

Most small law firms operate on a cash basis, accounting for cash as it comes in and goes out. Larger law firms maintain both cash and accrual records. I believe accrual accounting is superior, because it allows you to look at both income and expenses in the totality of your practice, not just as isolated events.

The problem with taking a short-term, cash-oriented perspective is that it can jeopardize your practice by keeping you from making needed purchases.

For example, small firm lawyers know they must keep up with technology changes but many resist buying or updating technology because they are overwhelmed by the high up-front expense. They may be on a four, five or even six-year upgrade grid because they fear the initial outlay. Compare that to the large firms that I have surveyed, two-thirds of which are on a three-year upgrade cycle.

Of course, there are also dangers in focusing only on the long term and ignoring immediate cash flow.

Another solo practitioner who I recently counseled had a strong practice, but one with lagging profitability. This lawyer, on the advice of her accountant, was purchasing all her office equipment in order to get the tax deductions. What she needed to do instead was maximize her equipment leasing, in order to improve near-term profitability and cash flow.

The lesson, I believe, is don't look at expenses in isolation. Take your office space expenses, for example. Certainly you cannot be too far out of line with your competitors and still stay in business. But remember that your office space speaks loudly and clearly to clients about the quality of your firm.

Shortchanging yourself on what you spend may look good on your short-term bottom line. But all of your expenses are ultimately a reflection of your firm's overall objectives. Ask the proper questions about them, and look at them in the context of your complete practice goals.

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