Latest / Wealthy Woman Lawyer Podcast, Helping you create a profitable, sustainable law firm you love / Episode 345 | Why Your Best Revenue Year Left You Broke: The Cash Flow Truth No One Tells You

Transcript

Episode 345 | Why Your Best Revenue Year Left You Broke: The Cash Flow Truth No One Tells You · Wealthy Woman Lawyer Podcast, Helping you create a profitable, sustainable law firm you love

• 0:01
  Intro: Welcome to the Wealthy Woman Lawyer Podcast. What if you could hang out with successful women lawyers, ask them about growing their firms, managing resources like time, team, and systems, mastering money issues, and more. Then take an insight or two to help you build a wealth generating law firm. Each week, your host, Devina Frederick, takes an in-depth look at how to think like a CEO, attract clients who you love to serve and will pay you on time, and create a profitable, sustainable firm you love. Devina is founder and CEO of Wealthy Woman Lawyer, and her goal is to give you the information you need to scale your law firm business from 6 to 7 figures in gross annual revenue so you can fully fund and still have time to enjoy the lifestyle of your dreams.
• 0:47
  Now, here's Davina.
• 0:53
  Ryan: Hello, I'm Ryan Kimmeler, founder of the Net Profit CFO and CFO coach for Wealthy Woman Lawyer. Devina has asked me to take over her podcast today and talk about the cash flow drivers of business. Stick around till the end and I'm gonna share with you an exclusive offer for Wealthy Woman Lawyer Podcast listeners only. So, let's dive in. This is one of my favorite topics to talk with clients about.
• 1:20
  I'm sure if you're listening and tuning in, you all have been there where you go and talk with your CPA probably around tax time or or getting your taxes done. You walk in, they're reviewing kind of the return and your numbers for the year and they probably say something along the lines of, wow, you had a really great year this year, great job, congratulations, and something to that effect and inside, you're like, where's the money in the bank, right? And you're thinking, it doesn't feel like I had a really great year, right? And wondering where all the money went or how your accountant is looking at things differently than you are and so that's what we're going to dive into today. There's a lot of transactions that happen between net profits of a business which is probably what your accountant was looking at and net cash flow which is money that actually gets added to the bank and left in the bank account.
• 2:23
  So, there's a lot of transactions that happen in between there. Let's dive right in. Alright, first and foremost, if you don't know how to get down to net profits on the profit and loss statement or or income statement, tune back into the episode, the last episode that I did where I talked about the five profit drivers. So, the profits are going to tell you the net operate, the net operating profit or net income is going to tell you really the efficiency of your business. It is what I like to call profits from operations.
• 2:59
  So, it's the profit that the business produces from you operating and being in business. So, that's after all of your expenses are paid. You know, based on the revenue that you've brought or sales that you've brought in the door. So, let's dive into what happens after that. So, let's just say, for argument's sake, just as an example, you run a business and at the end of the year, you have a million dollars in profits.
• 3:29
  Your taxes and taxable income is going to be based on your net profits. So, it's not the sales of the business, it is the net profits of the business which takes into account after you've paid expenses. So, million dollar business, one of the first things that happens, again, after you've got your million dollars in profits is you're going to pay taxes. Let's just say for easy round numbers, federal and state and local taxes. Let's just say that that's 30%.
• 4:05
  So, dollars 300,000 of the million dollars goes to pay taxes. That is something that you cannot expense. So, obviously, you know, we just ended the the 2025 year. We paid those taxes in 2026. You cannot take your tax payments and say, oh yeah, I'm going to expense that in 2026.
• 4:32
  The IRS and and all the agencies don't allow you to do that. Paying taxes is does not count as an expense. Most generally, for for most all of the entity structures that we have in The United States. In some some cases, C corporations, that's that's not the case but for for most entities that law firm owners own, partnerships, LLCs, LLCs that are taxes and S corp, the taxes are your personal liability and you cannot expense them through your business. So, that's the first thing that happens that if you make a million dollars, you're not gonna add a million dollars to the bank.
• 5:20
  So, a million dollars in profits, you're not gonna keep a million dollars in the bank because you've gotta pay taxes. So, that's part one. Then, after taxes, there's still a lot of other transactions that have to take place before we get down to what's actually in the bank. One of the next big items is what we call accounts receivable. From the accounting side of things, accounts receivable are bills that you've done the work at your law firm.
• 5:55
  You've issued invoices to your clients and they have not paid you yet. So, this is, you know, basically your customers, your clients, owing you money. So, obviously, if you know, we're factoring that into the sales of the business but you haven't actually been paid that yet at the bank level, that's money that you don't have yet. So, out of the million dollars, if you have clients that still owe you money, that's not gonna show up as cash in the bank. So, that's one of the things you gotta account for and take out.
• 6:37
  You know, for most law firms, eventually, you do end up collecting the majority of your money. I think, you know, Cleo, Cleo's statistic is typically around 85 or 86% of billings end up getting collected within ninety days. I think that's their ninety day rate from their study. So, if you're doing a good job of collecting, that's great. That's really going to help your cash flow and then I'm sure that there's some of you listening that maybe you've had to send things to collections.
• 7:11
  And you've not actually collected on it. That obviously is going to affect the cash that's in the bank. So, that's the first thing that we have to account for after taxes, accounts receivable, invoices that are owed to be paid to you. Okay? Next thing that I wanna get into is assets.
• 7:35
  So, any purchases of assets for your law firm, the IRS, and again, government agencies, they don't let you write off or expense big asset purchases. So, if you went out and let's say you bought a building to have your office in and let's just say, it's a million dollar building. You put down $200 a bank or lending institution loaned you 80%, dollars 800. The IRS does not allow you to write off the full million dollars in one year. Instead, they say that is an asset that is going to be around for many, many, many years and therefore, so that they can collect more tax money.
• 8:24
  They say that you have to write that off over a schedule of years. So, any purchase of assets is going to take cash out of the bank and you do not get to directly write the whole entire thing off. Other examples of assets would be furnish furnishings, furniture. If you are going to furnish a new office space or potentially a building that you purchased. Let's say you went out and spent $15.20 grand, $30, whatever it is on furniture, it is also classified as an asset and you cannot write that off as well.
• 9:05
  That's a fixed asset. Company cars. Same way, if you, if you went out and bought a nice company car for your law firm, that is also something that does not get written off in year one and so, that also can take cash out of the business. Let's say you put down a down payment, maybe some of it was financed and that that's an area where again, you're going to take cash out of the bank account to go and put down money for that car. That is not going to be, you know, that's gonna be not gonna be accounted for in your profits.
• 9:45
  It's after profits. All the items that I'm talking about here, all these purchases would be after profits. So, it's after profit activity. So, those are that that covers the main asset purchases. There could be other things maybe like computers if if they're really expensive computers or potentially proprietary software if you're investing in something like that or potentially AI software maybe specifically for your firm.
• 10:17
  Those would be items that potentially you're not writing off the full thing in year one if they're big investments. So, those are items. Again, that's all gonna take cash that you're that's gonna take cash out of the bank that is not gonna be accounted for when you're looking at, you know, a million dollars in profits on the page. Next big item that I wanna discuss is paying back debt. So, if you leverage a line of credit for some operating expenses at one point or another or even credit cards that don't get paid off in full, paying back principal debt, does take cash out of the bank after profits.
• 11:09
  So, even a even a car loan, same thing, right? So, where this can get kind of confusing, convoluted. Let's let's just say you're making a payment for a vehicle that you've purchased. And just to make things really, really easy, round numbers, let's say $400 goes to pay the actual loan. Let's just say $50 goes to pay interest.
• 11:38
  So, $4.50 payment in total. The interest portion is actually tax deductible. So, you can write off interest expense on loans. So, that would be something that would already be accounted for in the business that I'm talking about. In the business that has a million dollars in profits.
• 12:01
  The principal payment though is not accounted for is not taking taken out of profits. Paying back debt, the principal on debt is not taken out of profit. So, if you had a $400 a month payment, you know, that's going to be $4,800 That's not, that's, that's taken out of the bank after profits. So, it's you know, it's really important and and I talk with the clients that I work with and the and law firm owners a lot about it it's it's really hard to pay back a lot of debt. It takes a lot, right?
• 12:47
  Because you have to run your business down to a good profit margin. Then, you've gotta pay taxes and then, you can pay principal debt. So, there's a lot of things, a lot of transactions that have to take place before you're actually making a dent in principal debt. So, you know, for for all my clients, we always put together, if there's debt on the books, we always put together what's our annual plan for paying back debt because I know that that is going to take cash flow out of the business. So, literally, dollars out of the bank account, right?
• 13:27
  Again, after taxes. So, if in order for you to make $5.00, let's just say, let's round up here a little bit and let's say principal payments on a on a car loan, you actually have to have more than $5.00 in profits. You know, because you're going to pay taxes. Probably, you know, more like $67 $8.00 to make $5.00 in payments. Maybe even more than that, right?
• 14:00
  And so, this is where, you know, again, debt can be dangerous and it's definitely going to take cash out of the bank. Alright, so that's the next big item again that I that I wanna discuss that takes cash out of the bank that happens after profits. So paying and that's any loans. Credit cards, car, car loans, loans for buildings, operating lines of credit, even loans for case cost financing. You know, if you're passing that through to clients, that's fine.
• 14:43
  That's that makes it a wash and then you're just expensing the interest. But if you're using, you know, like an operating line of credit for case case costs, and you're not charging your clients, if you have a flat rate service, and that, that, those fees are included in that flat rate service, then, paying back the principal on that debt is going to be, again, after profits, after taxes. Last item that I wanna get into here that is going to really affect cash at the bank, and that's going to be owner's distributions or owner's draws. So, as an owner, obviously, that's for most of you listening, that's probably the the the way that you pay yourselves. Probably the majority of the compensation that you give yourself.
• 15:36
  So, any kind of draws, bonus payments, anything that is not run through payroll is going to be taken as a distribution. So, distributions are going to take money directly out of the bank account. Again, to go pay yourself after profits. So, again, that's that's gonna be one of the big differences between here's what my net profits were and here's what actually changed or actually happened at the bank. One big kind of again, misunderstanding or or confusion, area of confusion that I talk with my clients about a lot.
• 16:24
  Again, I want to go back to taxes. So, again, with most of the entity structures that we have in The United States, the taxes are the personal liability of the owner. So, if you own an LLC and let's say you distribute money to yourself to pay taxes or let's say you pay money to the IRS directly to pay taxes out of the business account. That is even even if you take it directly out of the business account and pay the IRS, the IRS really views that as you paid it to yourself first and then, it came from you personally because all of the tax liabilities are personal liabilities. So, if again, let, again, let's just take this case study, right?
• 17:20
  A million dollars in profit and again, let's just say $300.00 in taxes just for round easy numbers and let's say you distribute another $300.00 to yourself over the course of the year, bonuses, and everything included for you to live life and pay your own bills and as personal compensation. In total, when you do your tax return that next year, you're actually going to have $600.00 in your distributions account or your equity account. That was paid to out to you that's gonna be recognized as personal compensation. Okay? So, profits of the business, we got a million dollars.
• 18:04
  Total personal compensation to you 600 ks because you got $300.00 in taxes, dollars 300 in paying yourself. Again, that's that's hypothetical and if there were not other items that took up the rest of the cash flow, you're going to, you know, you're going I mean, either way, you're going to put down a million dollars in income on your on your tax return from the business, right? That that number is going to be on there but how much you take in as personal, right? In distributions is going to be dependent on how much you actually take out of the bank account and pay yourself. So, that's definitely an important concept again that I talk with my clients a lot about is the money that's paid to you and distributions is what you pay yourself to pay your own bills and what you pay yourself to pay taxes.
• 19:03
  So, just to recap here today, before we get down to net cash flow at the bank, whether that's an increase or decrease. You know, so that would be, let's say, hypothetically, you looked at your bank statement, 01/01/2025 and then you looked at your bank statement 12/31/2025. When I say, what's the net cash flow or the net cash change? It's the change in your operating account bank statement. So, if you started the year January 1 with $100.00, you ended the year December 31 with $200.00.
• 19:42
  That's a positive 100 and $100,000 of positive cash flow. So, again, to get there and to get down to that number, we start with net income from the business. Then, you have to factor in and take out clients that have not paid you, that you've, you know, billed in the last year if you're looking at it on a yearly basis. Then, you have to factor in any major asset purchases. So, that would be cars, buildings, potentially computer, software, tools that you invest in, things like that.
• 20:21
  If they're really big projects and and proprietary, Not like I'm investing in a case management software, you know, on a monthly fee. That's not a that's not a software that you own. I'm I'm talking about something that you build that's proprietary, right? That's a big purchase, lot of development cost. Then, we have to take out the principal payments from debt.
• 20:46
  So, not interest, principal payments from debt, then, you've got to account for distributions and money that was paid out to you and then, you're going to get down to net cash flow. Okay? So, a lot of transactions take place after profits, right? And and taxes is in there a couple of times, right? We've gotta take taxes really off of the top and a lot of times, again, that's going to show up in your distributions account as payments out to you.
• 21:25
  Alright. So, those are the key drivers of cash flow and those are the reasons why your accountant might say you had a really, really great year. You might have a million dollars in profits and only add $100.00 to the bank in cash flow because there's so many transactions that happen in between profits and net cash flow. So, there's a lot of things going on, lot of moving pieces. It is not an easy, straightforward calculation by any means because there's so many factors and so many changes that could be taking place.
• 22:06
  So, I want to thank you for listening and tuning in to the Wealthy Woman Lawyer Podcast for specifically for listeners, use the keyword profit for your free financial assessment. I will cover the cost of it. It is a three year analysis of profitability, cash flow, breakeven, growth analysis as well, all rolled into one. So, you can see where the business has done well, what your some of your red flags might be, and places where you need to improve. Again, keyword, profit, and until next time everyone.
• 22:46
  Go accelerate your profits, improve your cash flow, build a healthy financial company. See you.
• 22:55
  Intro: If you're ready to create more of what you truly desire in your business and your life, then you'll want to visit us at wealthywealthywomanlawyer.com to learn more about how we help our clients create wealth generating law firms with ease.