Eight Strategies to Help Managing Partners Enhance Cash Flowby Joel A. Rose
Managing partners can enhance their firm’s cash flow by paying attention to the following eight strategies that contribute to proper financial management:
Attorneys in a law firm must adhere to systems and procedures designed to manage and control the financial aspects of their firms’ practice. The implementation of these systems and controls by managing partners do not engender "love" from their partners. Nevertheless, careful financial planning and control will bring rewards by improving operating results and eliminating unhappy or even painful surprises.
Managing partners must understand that cash flow, 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, and a decrease liabilities, including capital accounts, will reduce cash. But the reverse can be true - a decrease in assets and an increase in liabilities, including capital accounts, increase cash.
The depletion of cash from distributions to partners, the purchase of automated equipment, the repayment of bank loans and advances to clients, are examples of transactions which do not show up in the income statement, yet can materially affect a firm’s cash position. Therefore, the Application of Funds Statement, a financial report usually prepared by the firm's administrator or accountant, which combines the effect of net income plus depreciation and balance sheet transactions, requires careful analysis on a continuing basis.
A well conceived business plan offers a road map for the future. It 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 objectives agreed to by the partners. Financial statement analysis records history and will tell you whether you are on or off course. However, without an appropriate business plan, controlling cash flow and improving financial management are impossible.
Even if the firm’s objectives are purely financial, they will require a business plan and the necessary follow up by the managing partner to insure that the initiatives to accomplish the partners’ objectives have been implemented.
The financial plan follows the business plan in that it spells out the investments, commitments, financial resources and bottom line results that may be expected from the implementation of the business plan.
The business plan may identify the fields of health law, intellectual property, bankruptcy law, etc., as areas of opportunity. The financial plan should tell you the projected revenue as well as estimated costs and net income opportunities if your firm decides to embark in these directions.
Budgeting for revenue and expenses is a significant element of the financial plan. The budget should include the projected revenues and expenses.
Revenue Budgeting: It is not unusual for some managing partners to think that projecting revenue cannot be done with any degree of accuracy, since they may not know the specific sources of tomorrow's business. The answer is that managing partners can budget their firm’s revenues by (1) analyzing the firm's largest and/or most productive fee producing clients, (2) reviewing the relative standing of these clients as revenue producers over the last several years, (3)looking at the type of business they produced, and (4) talking to the billing partners responsible for each of these clients about those factors that may increase, or contribute to a leveling or diminution, in the volume of client work and revenue from these clients during the next year.
Even if an established firm has a “transactional” practice or works for a high number of “casual” clients - meaning that there is not a stable of key clients that contribute significantly to the firm’s revenue on a continuing basis - the managing partner can still budget revenue. If the firm has been in existence for five or ten years, or longer, the likelihood is that the firm will continue to provide similar types of services to its varied client base, even though its attorneys may not know for whom they will be performing this work six months down the road. By analyzing the firm’s historical data, the managing partner will be able to detect trends and client needs that can be translated into assumptions and revenue estimates.
If the firm does nothing more that ask each attorney responsible for a significant clients to provide an estimate of billings, the managing partner will be able to establish financial incentives for those lawyers who reach or exceed their own clients' revenue estimates.
It is my opinion that a sound revenue estimate is probably the most important step in budgeting, and for a variety of reasons. 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 pure guesstimates, with potentially adverse results, either on the up or the down side of the firm’s business cycle.
Expense Budgeting: Budgeting of expenses is easier because the commitments either are already made or result from decisions which at least appear more within the firm’s control than estimating revenue. However, the managing partner should 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?
For revenue and expense budgets to be effective, the firm’s attorneys (partners and associates), paralegals and administrative managers must believe that the budget is “their budget” both in terms or revenue and expenses. Therefore, the attorneys and the managers of the paralegal and administrative support functions should be involved in preparing and being accountable for complying with the budgeting process, to the extent possible.
The following three expense categories deserve particular attention:
(1) Entertainment and client development expenses.
Many firms allocate to each lawyer an annual budget based upon his or her anticipated volume of business or past records or some other standard the managing partner chooses to select. Review his or her expenditures and hold the lawyer 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.
(2) Telephone, mail, messenger expenses.
Control the use of these expenses through such devices as computerized code numbers for mail, duplicating, messengers, client advances, telephone, postage, etc. By creating and implementing these kinds of systems and controls, the recovery of such expenses from the clients should increase enormously. Whether clients are billed specifically for each such expense, or the firm calculates an average charge to each client, or the firm absorbs certain of these expenses, the managing partner still needs to know what these services cost and how to keep them under control.
(3) CLE Expense.
Many firms allocate to each attorney an annual budget for CLE courses. To control these expenses, firms place limitations on the location of particular courses, especially if the same course is to be presented locally. Also, some questions have arisen about the need for every associate to attend particular CLE courses. In response, many firms may send a select number of associates from a particular office to attend certain courses, purchase the tapes of these programs, or have the associat5es who attended facilitate discussions about the program with the others who did not attend.
Controlling client advances can be a challenge. Every litigator will say that the firm must advance filing fees. I have no problem with the firm advancing 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, SEC registration fees, expert witness expenses and so on.
The problem is made more complicated by the cash accounting practices of many law firms that do not show advances to clients as a reduction of cash on the income statement. Unfortunately, no matter how you account for client advances, they are a drain on your cash and their write-offs affect the firm’s net income.
To control advances to clients within reasonable limits, a combination of approaches, with persistent toughness, is required. A small minority of firms don’t permit advances at all; other firms insist on receiving from clients retainers or at least deposits to cover estimated advances, while some firms bill client advances immediately, separate and apart from fees.
Some firms record certain advances as expenses, e.g., contingent fees disbursements, and reflect them in their income statements to sensitize partners about the firm’s cash position. It is curious to note that more firms have started to (1) hold the billing or responsible lawyers accountable for client advances if payment is not received within a prescribed time, especially if retainers are not obtained from these clients at the inception of the matter, or if deposits are not received from these clients prior to incurring the advance, and (2) set “credit limits on cash advances” with prohibitions against the accounting department accepting requests for client advances in excess of a predetermined minimum amount, without prior approval of the managing partner.
One of the most expensive components of client advances has been travel. Many law firms, representing corporate clients that rely on in-house travel departments to reduce cost, place their lawyers’ travel expenses charged directly to the client will enhance your firm’s cash balance, not to mention the time savings for your accounting department.
Billing and Collection Practices
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.
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 timely billing - since more clients want monthly bills! Yet unbilled time inventories seem to be an ever increasing problem for many law firms.
Under systems that I would recommend for enhancing cash flow, each billing attorney is required to indicate every month when the matters for which he or she is responsible are expected to be billed and when their collections will be completed. It is suggested that billing attorneys, with unbilled time in excess of a specified amount for any client matter, be called upon personally by firm’s administrator to review unbilled time and accounts receivable.
If necessary, the managing partner, or his or her designee, will also make these rounds. In addition, by distributing monthly, to all partners, a report on each partner showing the unbilled time inventory, total accounts receivable, and unbilled time and accounts receivable over ninety days old, your firm will bring a little peer pressure to bear that will usually work wonders.
Obviously, a partner's compensation system that contains as one criterion the recognition of cash collection also encourages prompt billing and follow-up on accounts receivable.
The computerized invoice presents an additional opportunity. I have initiated at many law firms the system of centralized billing, rather than lawyer-initiated billing. One problem with centralized billing is obviously the matter of editing computer prepared invoices. However, as a rule, monthly billing firm-wide is the objective, and this goal can only be achieved with the help of a centralized billing system.
We recommend that the computer be programmed to prepare, monthly invoices for each client. The billing or responsible attorney reviews this invoice within a specified time limit and then the invoice is mailed to the client. The same system would be used for preparing and mailing reminder invoices when an invoice is not paid within a specified period of time.
Partner Compensation Systems
The firm’s compensation system should provide recognition of those lawyers who are prompt in billing and collecting, and if it does not, the managing partner should take steps top create one that does. . We recommend that this recognition be part of the discretionary portion of the firm’s profit distribution system.
Of course, certain types of legal business do not lend themselves to monthly billing - e.g., class=Section2> probate administration, contingent fee litigation, certain financing work, etc. However, there may be opportunities to build similar controls into the compensation system for these practice areas as well. For example, during a recent client assignment, the managing partner of a sizeable bankruptcy boutique retained us to find out why the firm was having cash flow problems, even though every attorney complained of being overworked.
After reviewing the firm’s financial data and management information, it became apparent that one of the partners who controlled a substantial number of clients and who kept several lawyers and many paralegals busy had failed to submit fee petitions to the Court in a timely manner because “he was too busy managing client files.” In the meantime, the firm received no revenue for these cases, even though the attorneys and support staff were extremely busy. Indeed, the rest of the firm was subsidizing the ineffective billing practices of this billing partner.
Although we endorse writing off old accounts, billed and unbilled, for purposes of determining current compensation, it may be prudent to keep records of these old accounts so that the billing or responsible attorneys may be treated appropriately in the compensation process.
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 to these problems 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 this committee. This committee should meet weekly or more frequently, as required. Any committee member may approve new matters which cannot wait for committee approval. The committee reviews the conflict of interest questionnaire, client credit information, applicable hourly rates and billing arrangements, and the confirmation letter proposed by the responsible attorney.
(2) The committee also reviews every invoice in excess of certain amount to determine the amount to be billed versus previously approved or agreed upon billing arrangements and applicable rates. Most lawyers in firms that have implemented such an approach have found the committee to be most helpful in ferreting out clients or matters which should be not acceptable, or acceptable only on the basis of an appropriate up-front retainer.
I need not mention the benefits of the conflict of interest review. Finally, it is expected that the review of invoices may produce noticeable results in increasing a 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 doing a better job in advising clients of the firm’s billing practices ahead of time, if they 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. Some receive interest on this capital account at the average prime rate, many others don’t.
In addition, based upon our analysis of financial data and management information, to insure the adequacy of cash flow, we have from time to time suggested that a firm withhold a certain percentage of the annual net income and distribute that amount at the beginning of the secondclass=Section3>
quarter of its next fiscal year, rather than borrow from the firm’s credit line. The cash flow from operations, partners' capital, and the percentage of net income held back enables many firms to limit their bank borrowing 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 on a short-term basis. Partners should be on fixed monthly draws that - cash flow permitting - can be supplemented with partial distributions on June 1 and September 1. However, partners' draws should be on the conservative side.
Finally, a caveat. Sound financial planning will help improve a law firm’s cash flow. The danger to be avoided is to hamstring a firm's daily practice with those kinds of financial systems and controls that 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 firms is their 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.
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