Edward Poll, The Daily Record Newswire
It may seem obvious, but some lawyers need reminding: Revenue has to exceed expenses in order to have cash flow. One important expense item that has a significant impact on cash flow is the partner's draw or lawyer's salary.
It's is a touchy area for most attorneys, because a lawyer's personal style of living and expenses become important considerations in any successful cash flow budget.
To help small-firm and solo practitioners in thinking about what they need to take out of a firm as an owner, I've developed a monthly expense hierarchy:
1) Practice needs
2) Personal needs
3) Savings for the "valleys"
4)Savings for emergencies/ retirement
5) "Gravy"
This expense hierarchy shows five levels, each representing the need for cash, in the order that a solo or small-firm practitioner should prioritize them for the health of the firm and the lawyer's own livelihood.
First, of course, come the needs of the practice. Without it, there's no source for personal needs. For a hypothetical one-lawyer firm, let's say that number is $8,000 a month.
Second are the lawyer's personal needs, as reflected by the draw or salary. What are all the expenses required by you and your family to maintain your style of living? This box should be the most flexible; that is, if the practice produces sufficient income, you can increase your standard of living.
But the better approach is to avoid committing yourself to extensive obligations from which you cannot retrench in time of need. Let's give our hypothetical solo lawyer with a small family $12,000 a month.
The third box is allocated to savings for the "valleys" of the practice. During each month, some funds should be set aside to carry the practice through those leaner times experienced by every lawyer and law firm, regardless of size.
The valleys are typically temporary interruptions of revenue caused by either a transitory shortage of funds from clients or a temporary lull in their legal requirements, resulting in an unsteady flow of funds. Our lawyer puts aside $2,000 during each of six "peak," or fat, months.
The fourth box is for personal savings for unexpected emergencies or retirement. Few of us are independently wealthy or maintain a second business activity that will provide ready funds for unanticipated uses down the road. Therefore, the best approach is to set aside a small sum each month and forget about it.
Without getting bogged down in investment theories, interest rates and the like, suffice it to say that because of the power of compounding interest, some sort of regular savings of even a small sum of money can grow significantly over several years. A quick rule of thumb is the "Rule of 72." Take an interest rate and divide it into 72 - that's how many years it will take for the money to double. Our lawyer socks away $200 a month for 10 years.
The last box is for "gravy." After setting aside money for each of the above categories, the balance should be considered a bonus. This is the money to reward yourself with a trip, a purchase of something special for you or the business, a speculative investment, a charitable contribution, etc.
So our hypothetical solo practitioner is spending approximately $21,000 a month, averaged over the course of a year, in the first four categories. If he pulls in, say, $24,000 each month in revenue, then there is an excess of $3,000 a month in gravy.
If, however, our lawyer is collecting only $18,000, then something has to give, and it will probably be the variable draw (personal needs).
-----
Edward Poll is the principal of LawBiz Management. He coaches lawyers and is the creator of "Life After Law," a program that helps attorneys plan for profitable exits. He can be contacted at edpoll@lawbiz.com.
Published: Tue, Apr 28, 2015
