Strategies That Keep Cash Flowing and Profit Margins Growingby Joel A. Rose
At meetings and retreats, law firm partners openly discuss the implications of the continued recession that has resulted in fewer clients, lower revenue, reduced profits, and, ultimately, the need for fewer attorneys at the partner and associate levels. Before taking drastic steps, however, partners and their managing-partner colleagues should consider implementing strategies such as those enumerated below that can maintain cash flow and improve margins:
(1) Engagement letters. Any program addressing cash flow and margins should begin with adherence to engagement-letter protocols. An engagement letter should define the firm’s specific work to be performed for the client, the billing and payment policy for that client matter, and the firm’s response if the client does not comply with the agreed-upon billing and collection policy.
(2) Retainers, advance fees, and security deposits. As a prerequisite to accepting representation, attorneys should require retainers from new clients. Also, encourage clients to agree to pay "evergreen retainers." This type of retainer allows the firm to bill against the retainer. When the balance of the retainer is reduced to a specific minimum amount, a bill is sent to the client to replenish the retainer balance.
It also should be mandatory for attorneys to obtain an advance fee or a security deposit from new clients. The advance fee payment, like a retainer, constitutes funds paid in advance for some or all of the work the attorney is expected to perform on the client’s behalf. The security deposit is a sum of money that will be held by the lawyer to secure payment of fees for future services that the attorneys are expected to render.
(3) Billing and collections. Generally, clients tend to pay their bills in relation to the promptness with which they are billed once the work is done. Since some time usually elapses after a client matter is completed and the bill is sent, the sooner a bill is mailed, the sooner a firm is likely to be paid. In an attempt to maintain a steadier flow of incoming cash, consider shifting to a continuous billing cycle throughout the month rather than waiting until the end of the monthly billing period to submit bills. To support this practice, the partner responsible for billing the matter should ensure that all lawyer time and disbursements are submitted promptly upon conclusion of the matter so that a bill can be prepared.
The shortening of payment cycles also has given added impetus to this procedure. If the firm completes work for a client at the beginning of the month and waits until the end of that month to submit the bill, payment may not be received until 60 days to 90 days after the billing date, thus lengthening the cycle to 120 days or more. If the client had been billed immediately after the work was performed, however, the payment might be received that much sooner. More frequent billing during the month will help the firm to avert a cash crisis and avoid the cost of borrowing money.
(4) Clients pay costs directly. Firms should encourage clients to pay costs directly. Rather than permitting "use" of the firm’s money, the clients should be billed for travel, litigation support costs, expert witness fees, and other major out-of-pocket expenses as they are incurred. Do not nickel-and-dime. Even clients who insist on being billed annually or at the end of a case should be willing to pay major-cost items advanced by the firm at regular intervals, at least quarterly, or when they exceed a reasonable amount.
(5) Peer pressure for unbilled time and receivables. Some firms are utilizing peer pressure to motivate partners who are delinquent in billing clients. These firms circulate a monthly report on late billers. The value of this practice is to apply some pressure to delinquent billers to be accountable to their partners for their "inaction." This method strives to encourage more timely billing and stresses that the behavior of one partner directly affects the well-being of every other partner in the firm. Some smaller and midsize firms have instituted monthly billing meetings to ensure that bills are prepared and reviewed in a timely and systematic manner.
A number of law firms reportedly are penalizing partners who have not satisfied their billing obligations. The firms acknowledge that although the partners grumble about this, the results have been effective. To further reinforce the importance of the billing process, a few firms actually have computed the interest that would be due if the firm were forced to utilize its line of credit to pay operating expenses and the partners’ salaries. The delinquent partners who do not bill in a timely manner must be made aware of the fact that when the firm’s source of cash is not tied up in unbilled time, distributions can be made on a regular basis.
(6) Write-offs/write-downs. Another method of expediting the billing process that is used by many firms is generally referred to as the "15 percent rule." This rule holds that the billing attorney may write-up or write-down a bill by up to 15 percent of the total fees independently without obligation to review the matter with any other partner. However, if the amount of the fee write-up or write-down is in excess of 15 percent, the billing partner must obtain the concurrence of the head of the practice area and managing or financial partner before submitting a bill to the client.
(7) Educate partners about firm economics. Many firms have authorized their administrators to educate partners about the financial realities of operating a law firm and the importance of billings and collections. The effort is meant to ensure that partners understand the necessity to bill and collect for work performed. In this manner, the partners are made to realize that since working capital is required to carry unbilled time, less unbilled time will result in fewer demands on the firm for cash.
The effort to regulate cash flow does not end with the billing of time and costs. To facilitate collections, most firms have developed a program that includes centralizing control over collections with an individual lawyer, a committee, or the firm’s administrator. When lawyers have to justify delays in billing or lack of follow-up on the collection of receivables to a designated individual or group, this creates a greater incentive for the billing lawyer to initiate the billing procedure and become more active in the collection process.
(8) Creditworthiness of clients. To gain better control over collections, more firms are screening incoming matters by evaluating potential clients’ creditworthiness before agreeing to commit the firm’s resources to their representation. One method of testing the client’s ability to pay is to request an initial retainer at the inception of the matter. Furthermore, an increasing number of firms have standardized policies concerning retainers and deposits. Arranging a monthly retainer billing schedule, for example, may enable the firm to regulate its cash flow.
Some firms have attempted to implement a program of charging clients interest for late payment of bills. However, more firms avoid this practice in favor of applying pressure on the billing attorney to determine the proper type of follow-up action that may be required to collect the receivable. In some situations, a reminder statement may be sufficient. In other cases, a telephone call from the billing partner may be necessary, and as a last resort, a personal visit may be in order.
(9) Purchases and payables. Periodically, every law firm administrator should review the cost of office supplies and related items to ensure that the firm is paying the lowest price available for the quality supplies, materials, and equipment required to operate the firm effectively. This will involve an ongoing comparison of vendors’ and suppliers’ rates and special offerings. Also review the terms of purchase orders and contracts in order to use the maximum time allowed before actual payment of bills. In today’s competitive environment, law firms should negotiate terms for payment to encourage lower prices, discounts, or extended payment schedules without incurring penalties or late charges.
(10) Cash management. Encourage all partners to promptly submit any checks they receive to the accounting department for deposit. In most firms, this is accomplished by centralizing the mail receiving and opening process so that all checks routinely are forwarded directly to the accounting department and the cover letter that may accompany the payment is routed to the billing lawyer. In order for the program to work effectively, the individual who opens the mail must be instructed to process the mail and checks accordingly.
The necessity for more stringent management of cash also has prompted firms to review their procedures concerning lawyer expense accounts. To expedite the billing of clients for costs advanced to attorneys for expenses, firms are establishing tighter controls over the blank checks once given to partners in advance of trips and other activities. As an added measure, most firms request that credit cards be issued in the partner’s name rather than the firm name.
This practice ensures that partners will submit their requests for reimbursement when they return from trips instead of waiting for the credit card company to bill the firm. This also places the burden of setting the billing process in action on the lawyer rather than the firm. Once the costs are routed to the bookkeeper or accounting department, a bill can be prepared and sent to the client in a timely manner so that the firm does not carry costs for an extended period of time.
(11) Establishing a capital reserve. Since the financial position of a law firm fluctuates in response to a variety of factors not necessarily within the firm’s control, such as general economic conditions and a client’s ability to pay bills promptly, many more firms have established the practice of maintaining a capital reserve. A reserve of working capital will enable the firm to maintain a reasonable cash position to accommodate operating expenses without resorting to the line of credit when receipts are poor but the firm’s financial obligations must be met.
Depending on the firm’s areas of practice and its collection policies, the general rule is to establish a cash reserve that is equivalent to one month to three months of operating expenses. In addition to maintaining a capital reserve, it is sound financial management to routinely set aside funds for specific purposes.
Monitoring the firm’s requirements for both present and future cash outlays will enable it to avoid getting caught short, which invariably results in dependence upon the line of credit and generates still more costs. Prudent cash management calls for the line of credit to be viewed as the line of last resort. Undue reliance upon the credit line can set in motion yet another drain on the firm’s available cash. Maintaining an adequate cash flow requires balancing the firm’s demands upon its reserves.
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