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Due Diligence: how to check that your firm is solvent

When you are admitted as an equity partner, you are expected to make a large financial contribution to the firm.  Never do this without doing a thorough check on your own firm’s financial stability.  You need to be confident how solvent the firm is now and how it’s looking for the future.

In this article, extracted from Poised For Partnership, I look at how you should go about checking the solvency of your firm.

Will your money be propping up an ailing firm?

This is a very real danger. If the firm collapses, you will be left with hefty personal debts and a severely – perhaps irrevocably – damaged reputation.

What do you need to see to check a firm’s solvency?

You need to see the last three years of annual accounts, plus the most recent management accounts available. Remember that annual accounts can often be out of date, and not show the current situation.

What should you check on the balance sheet?

The firm’s balance sheet gives you a snapshot of the financial position at a point in time.  You must check that the firm’s assets are greater than the liabilities.  Then, look at the level of working capital – this is current assets (not fixed assets) minus current liabilities. If working capital is negative, or very low, then the firm may have cash flow problems.

Other areas that should ring alarm bells are:

  • high borrowing level relative to share capital and reserves,
  • negative cash flow, or persistent long term cash flow problems,
  • debtors rising faster than turnover,
  • large amounts of capital tied up in work-in-progress,
  • high levels of written-off bad debts,
  • high net current liabilities – short term debts greater than readily realisable assets, and
  • unsustainability of partners’ drawings.

What should you do if you are concerned?

If you have any concerns about the financial situation in the firm, talk to the financial director about them. You should also get independent advice before committing your capital into the partnership.

This article originally appeared in a different form on the How to Make Partner website.

Heather Townsend helps professionals become the The Go-To Expert. She is the author of the  award winning and best-selling book on business networking, the ‘FT Guide To Business Networking’, Poised for partnership and the co-author of ‘How to make partner and still have a life’, and ‘The Go-To Expert’. Over the last decade she has worked with over 300 partners; coached, trained and mentored over 2000 professionals at every level of the UK’s most ambitious professional practices. 

Heather blogs regularly at How to make partner and still have a life and works with future and current Big 4 partners and professionals from mid-tier firms all over the world

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