STRATEGIES TO ENHANCE CASH FLOWby Joel A. Rose
Managing partners, financial partners, members of executive committees and administrators must devote more of their time today, than in the past, to planning and managing their firms' finances and those functions that improve the cash flow. This article describes six aspects of law firm management and economics which the author has recommended to managing partners, financial partners, members of management committees and law firm administrators to assist them improve their firm's cash flow. These factors include: (1) cash flow; (2) a business plan; (3) budgets for revenues, expenses and client advances; (4) partner compensation; (5) a recommended new business and billing committee; and (6) partners' capital and borrowing.
Good cash flow requires management and financial controls, two disciplines which operate as limitations on the independent actions of attorneys in group practice.
Attorneys realize that they must submit to systems and controls to manage the financial aspects of their practices in order to survive in the ever increasing competitive environment which has engulfed them. Nevertheless, the introduction and implementation of these systems and controls by lawyer management do not engender "love" from their partners. On the other hand, careful financial management will bring rewards in terms of improved operating results and avoidance of unhappy or even painful surprises.
1. Cash Flow
It is vital for lawyer management to understand that cash flow, although principally the result of your firm's net income flow with depreciation added back, is also affected by changes in their firm's balance sheet which do not "pass through" the income statement. For example, an increase in assets reduces cash; decrease liabilities including capital accounts reduce cash; and the reverse is true - decreases in assets and increases in liabilities including capital accounts increase cash.
The obvious cash drain from distributions to partners, the purchase of automated equipment, the repayment of bank loans, borrowing, and advances to clients are examples of transactions which do not show up in the income statement, yet can materially affect cash. Therefore, the Application of Funds Statement, a financial report prepared usually prepared by the firm's administrator or bookkeeper, which combines the effect of net income plus depreciation and balance sheet transactions, requires careful analysis on a continuing basis.
A well conceived budget and business plan offers a road map for the future. Financial statement analysis records history and will tell you whether you are on or off course, positively or negatively. Without appropriate planning, controlling cash flow and improving financial management are impossible. There is really no mystery to this concept of cash flow, yet I never cease to wonder how often partners in law firms believe that capital expenditures affect net income.
2. Business Plan
Your firm should have a business plan which spells out those strategies and initiatives that the firm, its practice groups and individual attorneys intend to implement to reach the immediate and longer term goals and objectives agreed to by the partners. Even if the goals are purely financial, they will require a business plan and the necessary follow up by lawyer management to be achieved.
3. Financial Plan
The financial plan follows the business plan in that it spells out the investments, commitments, financial resources and bottom line results which can be expected from the implementation of the business plan.
The business plan may identify the fields of toxic waste disposal, health law and bank holding companies as areas of opportunity. The financial plan should tell you the estimated cost and income opportunities if you decide to embark in that direction.
Budgeting is a significant element of the financial plan. The budget should include the projected revenues and expenses. The assumptions underlying the budgets in each of these areas should be carefully developed and understood.
During law firm retreats which focus on methods for improving revenues and retained earnings, it is not unusual for some partner to say that it cannot be done because lawyers never know where tomorrow's business comes from. The answer is that revenues can be budgeted by analyzing your firm's largest clients, review their relative standing as revenue producers over the last several years, look at the type business they produced, talk to the lawyers responsible for each such client. Pretty soon, you will be able to detect trends and client needs which can be translated into assumptions and revenue estimates. If your firm does nothing more that ask each attorney responsible for a significant client to give an "off the cuff" estimate of billings, you will be able to establish a data base for your revenue estimates. Should you have enough courage, you might consider establishing financial incentives for those lawyers who reach or exceed their own clients' revenue estimates.
A sound revenue estimate is probably the most important step in budgeting - a law firm is highly labor intensive (personnel and related expenses being by far the largest cost) and lawyer hiring decisions tend to be made at least once a year in advance. In the absence of revenue estimates, hiring decisions will be made from the seat of your pants, so to speak, with potentially adverse results, either on the up or the down side of your business cycle.
Budgeting of expenses is easier because the commitments either are already made or result from decisions which at least appear more in your control than revenues. However, lawyer management in your firm must establish appropriate and reasonable policies to control expenses. What good is the finest expense budget, if it is not enforced or if the persons affected by it do not have an incentive to live within that budget. People must feel that the budget is "their budget" both in terms of revenue and expenses. All departments and functions of the firm should be involved in the budgeting process.
Expenses, include not only operating expenses, but also capital expenditures. Some expense categories deserve particular attention.
Entertainment and client development expenses: Allocate to each lawyer an annual budget based upon his or her anticipated volume of business or past records or any other standard you choose to select. Review his or her expenditures and hold them accountable. A simple start is to keep a separate ledger on each lawyer and require that each request for reimbursement contain a written justification for the proposed expenditures.
Control the use of facilities through such devices as computerized code numbers (i.e., Danyl System) for mail, duplicating, messenger, client advances, telephone, postage and similar expenses. Your firm's recovery of such expenses from the clients should increase enormously. Whether you bill your client specifically for each such expense, or make an average charge to each client, or absorb the expense, you still need to know what these services cost and keep them under control.
Client advances. For years this category of expenses has been of great concern. Controlling these advances is not easy. Every litigator will tell you that you must advance filing fees. I have no problem with filing fees, but when it comes to court reporters, costs of transcripts, exhibits, expert witness fees, etc., I see no earthly reason why these expenses cannot be paid directly by the client. The same is true with incorporation fees and charges, blue sky fees, SEC registration fees and so on. Part of the problem is created by the cash accounting practices of many law firms which do not run advances to clients through the income statement. Unfortunately, no matter how you account for client advances, they are a drain on your cash and their write-offs affect your net income.
To control advances to clients within reasonable limits requires toughness and a combination of approaches are needed: (1) don't permit them at all; (2) insist on retainers or at least on deposits to cover estimated advances; (3) bill client advances immediately and apart from fees; (4) record certain advances, i.e., contingent fee disbursements, as expense to reflect them in the income statement; (5) hold your lawyer accountable for write-offs; (6) insist that your accounting department do not accept requests for client advances in excess of a predetermined minimum amount.
One of the biggest components of client advances is travel expense. Many of your larger corporate clients have instituted in-house transportation departments which enable them to obtain significant savings. Why not place your travel and lodging arrangements through your clients' transportation department. The client will appreciate the savings and think what it will do to your cash balance, not to speak about saving the cost of your accounting department.
Converting a revenue budget into reality requires not only the efficient and effective handling of client business, but an effective discipline of billing and collecting for services rendered to clients.
Probably the most fundamental change in the practice of law resulted from the introduction of computerized timekeeping and the resultant enslavement of billing practices by the computer. Some say that "Billing rates and the computer have robbed the lawyer of his professionalism" - obviously an exaggeration, but what can be more degrading for a member of the "honorable profession" than to be asked by a client for his hourly rate. I am not a plumber. You have all heard the old story about the lawyer who complained about his plumber's bill.
Another problem is the time it takes to prepare a bill in the face of in-house counsel's demands for detail. Good cash flow requires prompt billing - the chances of collecting a bill in full and promptly are greatly increased by prompt billing - more and more clients want monthly bills! Yet unbilled time inventories seem to be an ever increasing problem for many law firms.
Under systems which I recommend, each billing attorney is required to indicate each month when the matters for which he or she is responsible are expected to be billed and when collection will be effected. It is suggested that billing attorneys with unbilled time in excess of $4,000 for any client matter are called upon personally by a member of the Business Administrator's staff to review unbilled time and accounts receivable. If necessary, a member of lawyer management will also make these rounds. In addition, I suggest distributing monthly to all partners, a tally sheet showing the unbilled time inventory, total accounts receivable, and unbilled time and accounts receivable over ninety days old of each partner - a little peer pressure seems to do wonders.
Obviously, a partner's compensation system which contains an element recognizing cash collection encourages prompt billing and follow-up on accounts receivable.
The computerized invoice presents an additional opportunity. I have initiated in many law firms the introduction of a system whereby centralized billing, rather than lawyer-initiated and manual billing, becomes the rule. A problem is obviously the matter of editing computer prepared invoices. Monthly billing firm-wide as a rule is the objective; in my opinion this goal can be achieved only with the help of a centralized billing system. My suggestion is that the computer should be instructed to prepare, monthly, the desired invoice for each client - the billing or responsible attorney reviews this invoice within a specified time limit and then the invoice goes to the client. The same system would be used for the mailing of reminder invoices when an invoice is not paid within a specified period of time.
While we are talking about invoices not being paid on time - we have discovered that placing Dun & Bradstreet's little gummed sticker on a reminder invoice can do wonders in speeding up certain collections. Many of our clients use it freely and it costs very little!
Compensation. Your compensation system should provide, and if it doesn't, you should consider it, recognition of lawyers who are prompt in billing and collecting. We recommend this be accomplished through the judgmental portion of your profit distribution system. Of course, certain types of legal business do not lend themselves to monthly billing - i.e., probate administration, contingent fee litigation, certain financings, etc. However, in that case you should recognize the time value of money in setting hourly rates and fees.
Old accounts, unbilled and billed, should be written off, not necessarily off the books, but for the purpose of determining current compensation. Some firms do this with respect to all accounts over one year old.
New Business and Billing Committee. In the old days, each partner made their own decision whether or not to take on a particular piece of business. Unfortunately, the growth of the business and the eagerness to take on new business, have led to billing and collection problems. My response has been the creation of a New Business and Billing Committee which serves several purposes:
(1) No new client matter (for a new or an existing client) can be accepted without prior approval of the committee. This committee should meet weekly. Any committee member may approve new matters which cannot wait for committee approval. The committee checks the conflict of interest questionnaire, client credit information, applicable hourly rates and billing arrangements proposed by the responsible attorney.
(2) The committee also reviews every invoice in excess of certain amount to audit the amount to be billed versus previously approved or agreed upon billing arrangements and applicable rates. Most lawyers have found this committee to be most helpful in ferreting out clients or matters which should be not acceptable, or only on the basis of a significant up-front retainer. I need not mention the benefits of the conflict of interest review. Finally, it is expected that the review of invoices will produce noticeable results in increasing your firm's realization of established billing rates and avoid discounting of time or rates.
It is a fact of life that most lawyers tend to be tough in evaluating business prospects, have more courage in billing top rates, and do a better job in advising clients of our billing practice ahead of time, if we have to account currently to a committee of peers.
Partners' Capital and Borrowings. For years, most firms have followed an arbitrary rule of thumb which calls for partners' capital to equal approximately 60 percent of the firm's investments in fixed assets, such as office equipment, leasehold improvements, etc. Partners add to capital each year and receive interest on this capital account at the average prime rate.
In addition I frequently recommend the firm withhold five percent of the annual net income and distribute same at the beginning of the second quarter of their next fiscal year.
Cash flow from operations, partners' capital, and the five percent hold back enables many firms to limit their bank borrowings to cover short term needs.
Cash balances should be monitored carefully to maximize return on cash. Most cash should be invested to the extent that firms sometimes have to borrow money short-term. Partners should be on fixed monthly draws which may be supplemented with partial distributions on June 1 and September 1, cash flow permitting, however, partners' draws should be on the conservative side.
In conclusion, I want to emphasize that systems and controls do not give you results in and of themselves. It is the quality of legal services, marketed in a common sense way, rendered to clients which produces the psychic and monetary rewards which lawyers seek.
Financial planning can only help improve the monetary aspect of this equation. The danger to be avoided is to hamstring the life of a firm's daily practice with those kinds of financial systems and controls which create unnecessarily burdensome obstacles to the servicing of client matters in a timely manner, and make little sense to anyone other than the individual who created the system.
The true measure of leadership of the lawyer managers of today's law firm is the ability to maintain a careful balance between the need to (1) encourage each lawyer's individual initiative, (2) provide for the much needed atmosphere of professional camaraderie so typical of the partnership type of law practice, and (3) plan and implement financial tools of modern business without which the best practice can fail.
©1999-2017 Joel A. Rose & Associates