One of the most difficult new responsibilities of running a solo practice is tracking and managing finances. From accounting software to bank accounts, most of it will be a completely new and foreign experience.
Once you have made the initial financial arrangements for your firm, you are ready for step two: dealing with cash flow and lines of credit.
Cash flow is different from generating receivables
Cash flow is money coming in your door and available for you to deposit and spend. That is much different than generating receivables and billing time. The quicker you can wrap your head around this concept, the better. For a small or solo firm, cash flow is critical.
For example, the majority of my cases are contingent fee cases. I don’t get paid unless I am successful and until I actually receive a check from the defendants. Some cases don’t resolve for months or over a year, others resolve relatively quickly. Either way, regardless of what I am getting from those cases, it doesn’t mean much until I get a check. They are good cases, but they can create a major cash flow crunch at certain times.
I also defend consumers in state court debt collection lawsuits. For those cases, I require up front payment—I get paid prior to completing the work. Most of these cases involve a limited scope representation—unbundled services like drafting an answer, discovery responses, or negotiating settlement. They don’t generate as much income per matter, but they are invaluable to my firm because they generate cash flow.
Figure out your monthly budget and if/what you need to pay yourself
If you are running a small firm or work as a solo attorney, you are likely handling your own bookkeeping. You should also know what your firm’s expenses are every month. Of course it will vary from month to month depending on your marketing plan, office supplies, networking lunches, rent, and other various expenditures. For the most part, however, you should have a good idea of what the monthly expenses are.
That monthly budget is your break even point. In other words, you have to bring in at least enough to cover your expenses. That may sound obvious, but lots of new attorneys magically forget about expenses (and taxes—but that’s for another post).
Once you know your budget, now you need to figure out what you need to pay yourself every month. Yes, most people like to get paid. At the same time, many solo attorneys are fortunate enough to have another income earner in the household. For many of those attorneys, income from their solo practice is not critical to supporting their household. Perhaps they can pay themselves just a couple hundred bucks one month, or even not get paid at all. That can certainly make things easier.
Assuming you need to pay yourself, figure out how much you need. Not how much you want to make, or you think you can make, how much you need to make in order to make your practice work. If you don’t have a household budget, now is the time to figure that out and determine your magic number.
Once you have that number, add it to your budget. That total monthly budget number is now much bigger than you ever expected and may be causing the following side effects: nausea, heart palpitations, nervousness, and second-guessing opening a solo practice. If you are experiencing of those side effects, congratulations, you are perfectly normal, healthy, and ready to start a solo practice.
That number is probably scary, but it’s also probably workable. Knowing that number will guide you, motivate you, and help you run a successful small firm.
Using credit cards and lines of credit to alleviate cash flow issues
Credit cards and lines of credit can be a fantastic way to create temporary solutions to cash flow issues. Note the use of the word temporary. Paying yourself (or expenses) with a credit card or a line of credit is simply delaying the due date on those payments, it is not a magic wand.
In other words, think of it this way: you need to pay yourself $3,000, but you don’t have $3,000 right now. In two weeks, however, you will receive a settlement check, of which you will receive $5,000. In that scenario, using a line of credit or credit card to pay your salary might not be a bad move. If you change that scenario to read: “in two weeks you have no money coming in the door,” advancing yourself money you do not have (and will not have) isn’t quite as smart.
Lines of credit
Lines of credit are nice because you can usually transfer funds instantaneously from your line of credit account to another account. If you need some instant cash into your business account, you are simply a few clicks away. There are two major downsides.
One, interest starts accruing immediately and daily. Credit cards give you a 21-28 day grace period—if you pay the bill in full, there is no interest. It doesn’t work that way with lines of credit. You take the credit, you start paying interest immediately, even if you want to pay it back in two days. Under certain scenarios, it might make sense to pay the interest. But you are also spending money to get money, which is generally a losing proposition.
Two, most lines of credit require a personal guarantee. If your business has a $12,000 line of credit, and you exhaust that line of credit and then default on it—they are coming after you. In addition, your contract probably says you agreed to pay their collection costs, interest, costs, and you may have waived a right to a jury trial. In other words: your firm defaults, you are in big trouble.
If you want a security blanket, lines of credit are nice. If you can exercise restraint and only use it if and when it is absolutely necessary, lines of credit are nice. If you simply want access to a big chunk of money and don’t understand cash flow, do not get a line of credit.
The alternative: firm credit card
Credit cards are nice because you can get your firm name on a piece of plastic. I guarantee it will make you feel more legitimate. That aside, credit cards usually have lower balance limits, offer fraud protection, and offer a grace period to pay off your balance without charging interest.
The lack of interest is a huge issue. That means you can pay expenses now on credit, and pay it back within weeks without having to pay interest. If you use it correctly, you can use a credit card to bridge the gap in cash flow, which will make your life much easier.
Fraud protection, travel insurance, and extended warranties are other bonuses or using credit cards. If you have ever had your identity jacked, then you know how important that can be. Unfortunately, like a line of credit, a credit card will usually require a personal guarantee. In my humble opinion, however, the advantages of a credit card are superior to a line of a credit, and worth putting your name on the dotted line.
Next up: you made money, now what?
The good news is that you will make money, hopefully even more money than you expected. The bad news is that you have to pay self-employment tax and cover for the month(s) when you will make zero, or even lose money.
Fortunately, having a plan can help you deal with taxes and months with little (or no) income.