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Avoid Tax Surprises by Forecasting Cash Flow

When the partners get their monthly financial packet, there’s one thing everyone wants to see: a high bank balance. But that can be a dangerous thing. A big number in the operating account is a recipe for temptation, especially if it leaps up due to a large cash settlement or referral fee. It can make partners expect an outsized distribution. 

John C. Scott, CPA, AEP

Instead, that money may be needed to pay operating expenses or build up cash reserves. On top of any upcoming projects, as much as 40% of your net income needs to be set aside and distributed quarterly for partner tax payments to avoid getting hit with a hefty bill (and penalties) come April.

If partners misinterpret a high bank balance and take too large of a draw, there are a number of potential consequences. For example, they might need to finance upcoming expenses with their line of credit, skip a future distribution or be asked to put money back into the firm — none of which are desirable scenarios to say the least.

So how do you ensure that everyone is on the same page when it comes to cash?


Start with good communication to help partners understand the firm’s operating account (for payroll and vendor bills) and cash reserves. Together, these accounts are considered working capital, but we highly recommend setting up two separate accounts, so that the numbers can speak clearly.

Your cash reserves account is where you build up 10% to 30% of annual revenue — $1.2 to $3.6 million for a $12-million firm. You’ll want to choose where you are on that spectrum based on several firm characteristics. Firms with greater risk, higher client concentration, lower recurring revenue and major plans for growth will tend towards the higher end of that range. However, there is no set formula, and a firm could choose to shift that number up or down for any number of reasons.

As your firm dials in its strategy, make sure partners understand the decision to hold onto cash — especially if it’s a larger amount than they’re used to seeing.

Reasons to hold onto (more) cash include:

  • Major upcoming investments (new technology, office space, etc.)
  • The firm is in high-growth mode (increase in annual revenue = increase in cash reserve balance)
  • Loss or scope-reduction of major clients
  • A high percentage of revenue comes from a single client (10% of revenue or more)
  • A weak pipeline of new business
  • Partner tax distributions (as much as 40% of net income)


The power of the partners’ financial report will depend on its real-time relevancy. A December 15 report that discusses October’s or November’s numbers is less impactful than one that explains what happened last week.

Although some finance professionals still believe they need a bank statement for reconciliation, it’s just not true anymore. Checking receipts and disbursements online every week takes relatively little time and, ultimately, simplifies end-of-month closings. As long as the firm’s billers are filling out timesheets daily — a best practice that unfortunately isn’t always followed — the weekly balance sheet should be accurate enough to be useful.

“The power of the partners’ financial report will depend on its real-time relevancy. A December 15 report that discusses October’s or November’s numbers is less impactful than one that explains what happened last week.”

This gives you the basis for a dynamic rolling forecast of your cash position: Every week, you can look at charge hour pacing, and change your expectation based on what people are actually charging. You can look at cash receipts, manage cash disbursements and update the dynamic forecast to determine what you expect your cash to be over the next 12 weeks on a rolling basis.

This to-the-minute detail can help bring partners into the conversation around cash. It’s easier to see distributions as part of a bigger-picture strategy when everyone can understand the direction the firm is headed, what needs to be done to get there and where improvements need to be made along the way.


Taxes can be a firm’s largest single expense. No one wants to miss estimates and get hit with penalties. Nor does anyone want to have to take out a loan to cover a shortfall.

If you’re doing a rolling forecast of your cash position, you can also forecast net income. With that information, you’ll know if income is rising, flat or declining, which will allow you to decide what to distribute on a quarterly basis to cover the owners’ taxes. If income is rising, the safe harbor approach allows you to pay 110% of the previous year’s bill in estimates, without penalty. If income is flat or declining, you can pay 90% of the previous year’s bill.

As you approach year end, you’ll also be aware of how much additional tax you might expect to pay in April or — if this year wasn’t as strong as last year — how much of a refund partners might expect to receive.


It’s common for partners to see a high bank balance and think that money is available for distribution, skipping crucial questions that can lead to a crisis come tax time.

However, if you create a real-time forecast that allows you to set aside the right amount for overhead, cash reserves and estimated quarterly taxes, you can be confident that the remaining cash balance sitting in the operating account is available for distribution.