Episode 345 | Why Your Best Revenue Year Left You Broke: The Cash Flow Truth No One Tells You

1 - > Intro: Welcome to the Wealthy Woman Lawyer Podcast. What if 2 - > you could hang out with successful women lawyers, ask 3 - > them about growing their firms, managing resources like time, 4 - > team, and systems, mastering money issues, and more. Then 5 - > take an insight or two to help you build a wealth generating 6 - > law firm. Each week, your host, Devina Frederick, takes an 7 - > in-depth look at how to think like a CEO, attract clients who 8 - > you love to serve and will pay you on time, and create a 9 - > profitable, sustainable firm you love.

Devina is founder and CEO 10 - > of Wealthy Woman Lawyer, and her goal is to give you the 11 - > information you need to scale your law firm business from 6 to 12 - > 7 figures in gross annual revenue so you can fully fund 13 - > and still have time to enjoy the lifestyle of your dreams. 14 - > Now, here's Davina. 15 - > Ryan: Hello, I'm Ryan Kimmeler, founder of the Net Profit CFO 16 - > and CFO coach for Wealthy Woman Lawyer. Devina has asked me to 17 - > take over her podcast today and talk about the cash flow drivers 18 - > of business.

Stick around till the end and I'm gonna share with 19 - > you an exclusive offer for Wealthy Woman Lawyer Podcast 20 - > listeners only. So, let's dive in. This is one of my favorite 21 - > topics to talk with clients about. 22 - > I'm sure if you're listening and tuning in, you all have been 23 - > there where you go and talk with your CPA probably around tax 24 - > time or or getting your taxes done.

You walk in, they're 25 - > reviewing kind of the return and your numbers for the year and 26 - > they probably say something along the lines of, wow, you had 27 - > a really great year this year, great job, congratulations, and 28 - > something to that effect and inside, you're like, where's the 29 - > money in the bank, right? And you're thinking, it doesn't feel 30 - > like I had a really great year, right? And wondering where all 31 - > the money went or how your accountant is looking at things 32 - > differently than you are and so that's what we're going to dive 33 - > into today.

There's a lot of transactions that happen between 34 - > net profits of a business which is probably what your accountant 35 - > was looking at and net cash flow which is money that actually 36 - > gets added to the bank and left in the bank account. 37 - > So, there's a lot of transactions that happen in 38 - > between there. Let's dive right in. Alright, first and foremost, 39 - > if you don't know how to get down to net profits on the 40 - > profit and loss statement or or income statement, tune back into 41 - > the episode, the last episode that I did where I talked about 42 - > the five profit drivers.

So, the profits are going to tell you 43 - > the net operate, the net operating profit or net income 44 - > is going to tell you really the efficiency of your business. It 45 - > is what I like to call profits from operations. 46 - > So, it's the profit that the business produces from you 47 - > operating and being in business. So, that's after all of your 48 - > expenses are paid.

You know, based on the revenue that you've 49 - > brought or sales that you've brought in the door. So, let's 50 - > dive into what happens after that. So, let's just say, for 51 - > argument's sake, just as an example, you run a business and 52 - > at the end of the year, you have a million dollars in profits. 53 - > Your taxes and taxable income is going to be based on your net 54 - > profits.

So, it's not the sales of the business, it is the net 55 - > profits of the business which takes into account after you've 56 - > paid expenses. So, million dollar business, one of the 57 - > first things that happens, again, after you've got your 58 - > million dollars in profits is you're going to pay taxes. Let's 59 - > just say for easy round numbers, federal and state and local 60 - > taxes. Let's just say that that's 30%.

61 - > So, dollars 300,000 of the million dollars goes to pay 62 - > taxes. That is something that you cannot expense. So, 63 - > obviously, you know, we just ended the the 2025 year. We paid 64 - > those taxes in 2026.

You cannot take your tax payments and say, 65 - > oh yeah, I'm going to expense that in 2026. 66 - > The IRS and and all the agencies don't allow you to do that. 67 - > Paying taxes is does not count as an expense. Most generally, 68 - > for for most all of the entity structures that we have in The 69 - > United States.

In some some cases, C corporations, that's 70 - > that's not the case but for for most entities that law firm 71 - > owners own, partnerships, LLCs, LLCs that are taxes and S corp, 72 - > the taxes are your personal liability and you cannot expense 73 - > them through your business. So, that's the first thing that 74 - > happens that if you make a million dollars, you're not 75 - > gonna add a million dollars to the bank. 76 - > So, a million dollars in profits, you're not gonna keep a 77 - > million dollars in the bank because you've gotta pay taxes.

78 - > So, that's part one. Then, after taxes, there's still a lot of 79 - > other transactions that have to take place before we get down to 80 - > what's actually in the bank. One of the next big items is what we 81 - > call accounts receivable. From the accounting side of things, 82 - > accounts receivable are bills that you've done the work at 83 - > your law firm.

84 - > You've issued invoices to your clients and they have not paid 85 - > you yet. So, this is, you know, basically your customers, your 86 - > clients, owing you money. So, obviously, if you know, we're 87 - > factoring that into the sales of the business but you haven't 88 - > actually been paid that yet at the bank level, that's money 89 - > that you don't have yet. So, out of the million dollars, if you 90 - > have clients that still owe you money, that's not gonna show up 91 - > as cash in the bank.

So, that's one of the things you gotta 92 - > account for and take out. 93 - > You know, for most law firms, eventually, you do end up 94 - > collecting the majority of your money. I think, you know, Cleo, 95 - > Cleo's statistic is typically around 85 or 86% of billings end 96 - > up getting collected within ninety days. I think that's 97 - > their ninety day rate from their study.

So, if you're doing a 98 - > good job of collecting, that's great. That's really going to 99 - > help your cash flow and then I'm sure that there's some of you 100 - > listening that maybe you've had to send things to collections. 101 - > And you've not actually collected on it. That obviously 102 - > is going to affect the cash that's in the bank.

So, that's 103 - > the first thing that we have to account for after taxes, 104 - > accounts receivable, invoices that are owed to be paid to you. 105 - > Okay? Next thing that I wanna get into is assets. 106 - > So, any purchases of assets for your law firm, the IRS, and 107 - > again, government agencies, they don't let you write off or 108 - > expense big asset purchases.

So, if you went out and let's say 109 - > you bought a building to have your office in and let's just 110 - > say, it's a million dollar building. You put down $200 a 111 - > bank or lending institution loaned you 80%, dollars 800. The 112 - > IRS does not allow you to write off the full million dollars in 113 - > one year. Instead, they say that is an asset that is going to be 114 - > around for many, many, many years and therefore, so that 115 - > they can collect more tax money.

116 - > They say that you have to write that off over a schedule of 117 - > years. So, any purchase of assets is going to take cash out 118 - > of the bank and you do not get to directly write the whole 119 - > entire thing off. Other examples of assets would be furnish 120 - > furnishings, furniture. If you are going to furnish a new 121 - > office space or potentially a building that you purchased.

122 - > Let's say you went out and spent $15.20 grand, $30, whatever it 123 - > is on furniture, it is also classified as an asset and you 124 - > cannot write that off as well. 125 - > That's a fixed asset. Company cars.

Same way, if you, if you 126 - > went out and bought a nice company car for your law firm, 127 - > that is also something that does not get written off in year one 128 - > and so, that also can take cash out of the business. Let's say 129 - > you put down a down payment, maybe some of it was financed 130 - > and that that's an area where again, you're going to take cash 131 - > out of the bank account to go and put down money for that car. 132 - > That is not going to be, you know, that's gonna be not gonna 133 - > be accounted for in your profits.

134 - > It's after profits. All the items that I'm talking about 135 - > here, all these purchases would be after profits. So, it's after 136 - > profit activity. So, those are that that covers the main asset 137 - > purchases.

There could be other things maybe like computers if 138 - > if they're really expensive computers or potentially 139 - > proprietary software if you're investing in something like that 140 - > or potentially AI software maybe specifically for your firm. 141 - > Those would be items that potentially you're not writing 142 - > off the full thing in year one if they're big investments. So, 143 - > those are items. Again, that's all gonna take cash that you're 144 - > that's gonna take cash out of the bank that is not gonna be 145 - > accounted for when you're looking at, you know, a million 146 - > dollars in profits on the page.

Next big item that I wanna 147 - > discuss is paying back debt. So, if you leverage a line of credit 148 - > for some operating expenses at one point or another or even 149 - > credit cards that don't get paid off in full, paying back 150 - > principal debt, does take cash out of the bank after profits. 151 - > So, even a even a car loan, same thing, right? So, where this can 152 - > get kind of confusing, convoluted.

Let's let's just say 153 - > you're making a payment for a vehicle that you've purchased. 154 - > And just to make things really, really easy, round numbers, 155 - > let's say $400 goes to pay the actual loan. Let's just say $50 156 - > goes to pay interest. 157 - > So, $4.

50 payment in total. The interest portion is actually tax 158 - > deductible. So, you can write off interest expense on loans. 159 - > So, that would be something that would already be accounted for 160 - > in the business that I'm talking about.

In the business that has 161 - > a million dollars in profits. 162 - > The principal payment though is not accounted for is not taking 163 - > taken out of profits. Paying back debt, the principal on debt 164 - > is not taken out of profit. So, if you had a $400 a month 165 - > payment, you know, that's going to be $4,800 That's not, that's, 166 - > that's taken out of the bank after profits.

So, it's you 167 - > know, it's really important and and I talk with the clients that 168 - > I work with and the and law firm owners a lot about it it's it's 169 - > really hard to pay back a lot of debt. It takes a lot, right? 170 - > Because you have to run your business down to a good profit 171 - > margin. Then, you've gotta pay taxes and then, you can pay 172 - > principal debt.

So, there's a lot of things, a lot of 173 - > transactions that have to take place before you're actually 174 - > making a dent in principal debt. So, you know, for for all my 175 - > clients, we always put together, if there's debt on the books, we 176 - > always put together what's our annual plan for paying back debt 177 - > because I know that that is going to take cash flow out of 178 - > the business. So, literally, dollars out of the bank account, 179 - > right? 180 - > Again, after taxes.

So, if in order for you to make $5.00, 181 - > let's just say, let's round up here a little bit and let's say 182 - > principal payments on a on a car loan, you actually have to have 183 - > more than $5.00 in profits. You know, because you're going to 184 - > pay taxes.

Probably, you know, more like $67 $8.00 to make 185 - > $5.00 in payments. Maybe even more than that, right?

186 - > And so, this is where, you know, again, debt can be dangerous and 187 - > it's definitely going to take cash out of the bank. Alright, 188 - > so that's the next big item again that I that I wanna 189 - > discuss that takes cash out of the bank that happens after 190 - > profits. So paying and that's any loans. Credit cards, car, 191 - > car loans, loans for buildings, operating lines of credit, even 192 - > loans for case cost financing.

You know, if you're passing that 193 - > through to clients, that's fine. 194 - > That's that makes it a wash and then you're just expensing the 195 - > interest. But if you're using, you know, like an operating line 196 - > of credit for case case costs, and you're not charging your 197 - > clients, if you have a flat rate service, and that, that, those 198 - > fees are included in that flat rate service, then, paying back 199 - > the principal on that debt is going to be, again, after 200 - > profits, after taxes.

Last item that I wanna get into here that 201 - > is going to really affect cash at the bank, and that's going to 202 - > be owner's distributions or owner's draws. So, as an owner, 203 - > obviously, that's for most of you listening, that's probably 204 - > the the the way that you pay yourselves. Probably the 205 - > majority of the compensation that you give yourself. 206 - > So, any kind of draws, bonus payments, anything that is not 207 - > run through payroll is going to be taken as a distribution.

So, 208 - > distributions are going to take money directly out of the bank 209 - > account. Again, to go pay yourself after profits. So, 210 - > again, that's that's gonna be one of the big differences 211 - > between here's what my net profits were and here's what 212 - > actually changed or actually happened at the bank. One big 213 - > kind of again, misunderstanding or or confusion, area of 214 - > confusion that I talk with my clients about a lot.

215 - > Again, I want to go back to taxes. So, again, with most of 216 - > the entity structures that we have in The United States, the 217 - > taxes are the personal liability of the owner. So, if you own an 218 - > LLC and let's say you distribute money to yourself to pay taxes 219 - > or let's say you pay money to the IRS directly to pay taxes 220 - > out of the business account. That is even even if you take it 221 - > directly out of the business account and pay the IRS, the IRS 222 - > really views that as you paid it to yourself first and then, it 223 - > came from you personally because all of the tax liabilities are 224 - > personal liabilities.

So, if again, let, again, let's just 225 - > take this case study, right? 226 - > A million dollars in profit and again, let's just say $300.00 in 227 - > taxes just for round easy numbers and let's say you 228 - > distribute another $300.00 to yourself over the course of the 229 - > year, bonuses, and everything included for you to live life 230 - > and pay your own bills and as personal compensation.

In total, 231 - > when you do your tax return that next year, you're actually going 232 - > to have $600.00 in your distributions account or your 233 - > equity account. That was paid to out to you that's gonna be 234 - > recognized as personal compensation. Okay?

So, profits 235 - > of the business, we got a million dollars. 236 - > Total personal compensation to you 600 ks because you got 237 - > $300.00 in taxes, dollars 300 in paying yourself. Again, that's 238 - > that's hypothetical and if there were not other items that took 239 - > up the rest of the cash flow, you're going to, you know, 240 - > you're going I mean, either way, you're going to put down a 241 - > million dollars in income on your on your tax return from the 242 - > business, right?

That that number is going to be on there 243 - > but how much you take in as personal, right? In 244 - > distributions is going to be dependent on how much you 245 - > actually take out of the bank account and pay yourself. So, 246 - > that's definitely an important concept again that I talk with 247 - > my clients a lot about is the money that's paid to you and 248 - > distributions is what you pay yourself to pay your own bills 249 - > and what you pay yourself to pay taxes.

250 - > So, just to recap here today, before we get down to net cash 251 - > flow at the bank, whether that's an increase or decrease. You 252 - > know, so that would be, let's say, hypothetically, you looked 253 - > at your bank statement, 01/01/2025 and then you looked 254 - > at your bank statement 12/31/2025. When I say, what's 255 - > the net cash flow or the net cash change? It's the change in 256 - > your operating account bank statement.

So, if you started 257 - > the year January 1 with $100.00, you ended the year December 31 258 - > with $200.00. 259 - > That's a positive 100 and $100,000 of positive cash flow.

260 - > So, again, to get there and to get down to that number, we 261 - > start with net income from the business. Then, you have to 262 - > factor in and take out clients that have not paid you, that 263 - > you've, you know, billed in the last year if you're looking at 264 - > it on a yearly basis. Then, you have to factor in any major 265 - > asset purchases. So, that would be cars, buildings, potentially 266 - > computer, software, tools that you invest in, things like that.

267 - > If they're really big projects and and proprietary, Not like 268 - > I'm investing in a case management software, you know, 269 - > on a monthly fee. That's not a that's not a software that you 270 - > own. I'm I'm talking about something that you build that's 271 - > proprietary, right? That's a big purchase, lot of development 272 - > cost.

Then, we have to take out the principal payments from 273 - > debt. 274 - > So, not interest, principal payments from debt, then, you've 275 - > got to account for distributions and money that was paid out to 276 - > you and then, you're going to get down to net cash flow. Okay? 277 - > So, a lot of transactions take place after profits, right?

And 278 - > and taxes is in there a couple of times, right? We've gotta 279 - > take taxes really off of the top and a lot of times, again, 280 - > that's going to show up in your distributions account as 281 - > payments out to you. 282 - > Alright. So, those are the key drivers of cash flow and those 283 - > are the reasons why your accountant might say you had a 284 - > really, really great year.

You might have a million dollars in 285 - > profits and only add $100.00 to the bank in cash flow because 286 - > there's so many transactions that happen in between profits 287 - > and net cash flow. So, there's a lot of things going on, lot of 288 - > moving pieces. It is not an easy, straightforward 289 - > calculation by any means because there's so many factors and so 290 - > many changes that could be taking place.

291 - > So, I want to thank you for listening and tuning in to the 292 - > Wealthy Woman Lawyer Podcast for specifically for listeners, use 293 - > the keyword profit for your free financial assessment. I will 294 - > cover the cost of it. It is a three year analysis of 295 - > profitability, cash flow, breakeven, growth analysis as 296 - > well, all rolled into one. So, you can see where the business 297 - > has done well, what your some of your red flags might be, and 298 - > places where you need to improve.

Again, keyword, profit, 299 - > and until next time everyone. 300 - > Go accelerate your profits, improve your cash flow, build a 301 - > healthy financial company. See you. 302 - > Intro: If you're ready to create more of what you truly desire in 303 - > your business and your life, then you'll want to visit us at 304 - > wealthywealthywomanlawyer.

com to learn more about how we help our 305 - > clients create wealth generating law firms with ease.