We often come across managing partners, other partners, and finance heads brainstorming over how to improve the profitability of a law firm or individual practices/teams. Sometimes, entire committees of experts focus on augmenting the top line and pruning expenses for a better bottom line. However, too often firms underrate the importance of maintaining a steady cash flow. Having a well-organized cash flow mechanism can help a firm avoid falling into trouble with a line of credit, and are a prerequisite for a firm to sustain and survive in the long run.
Thoughtful firms understand the importance of engineering the flow of their funds in a manner that automatically shields them from steering the firm into troubled waters. Through this engineering mechanism, some law firms survived the economic decline while others did not. Firms that focused on growing their revenues and clientele and structuring their cash flows did well; those that did not often collapsed.
The following best practices in finance management in law firms reduce the risk of liquidation and help the firm to chart a course for long-term success.
Start with a Plan
A smart strategy and business plan are necessary for a firm to identify its recovery cycles and expenses throughout the year. For instance, if the firm decides to open a new office in another jurisdiction, it will require funds to set up the office and run the practice. Once the short and long-term goals are identified by the firm, they should be spelled out in a proper business plan, with a strategy and budget to implement the goals. Based on the business plan, a financial plan details the investments and other financial resources required for executing the business plan.
It is important to highlight the projected income and expenses while preparing the budget. The involvement of all teams and departments of the firm in the formation of a budget is of vital importance. Matters regarding operational expenses, capital expenditures, etc., should get detailed attention while budgeting. The potential revenues of the firm can be projected by carefully analyzing the top clients of the firm and the nature of the firm’s engagements. Trends can be assumed and converted into tentative revenue estimates by the senior management of the firm.
Having a strong budget plan also results in a systematized outflow of funds. Expenses like photocopying, telephone, mailing, stationery, and use of other such items can be regulated by the management if budgeted. Budgeting will give management an idea of such costs, as well as how much of the expenses can be recovered from clients or borne by the firm itself.
Keep the Billing Cycle Moving
The system of internal checks and balances is of critical importance. To ensure that all services provided are billed correctly, a fool-proof billing mechanism needs to be implemented in the firm. This is a simple audit technique, and it will not only guarantee accurate billings but will also diminish the possibility of revenue loss arising from erroneous billing procedures. It is important to note that delay in releasing bills will adversely affect the cash inflows of the firm and will hamper the functioning of the firm.
The traditional process of lawyer-initiated manual billing has been replaced by centralized billing systems and has already been implemented by law firms worldwide. The invoices are generated digitally and reviewed by the attorney before being sent to the client. In a situation where bills are pending beyond a certain time limit, the software automatically sends reminders to the clients. Having a centralized billing system reduces the scope of human error and makes follow-up tasks faster and easier. Operational checks and balances procedures, such as tallying the court appearances with matter hearing lists issued by the courts, come in handy while ensuring that the bills pertaining to court appearances are not left out.
In a time when nearly every communication is done via e-mail, a central monitoring system to track the heavy inflow and outflow of e-mails would help in assuring none are left unattended. The faster the turnaround, the faster the billing and resultant recovery of expenses. Law firms should realize that billing is the first step for the recovery. To ensure a faster billing procedure, real-time invoices can be raised by digital billing software based on the data available on the e-mail server.
Overhead and Credit Periods
Paying client expenses out of the firm’s pocket adversely affect the cash flow of the firm. Many clients have denied reimbursement for items like photocopying, postage, office supplies, secretarial services and other administrative charges, which eventually affects the firm’s cash flow. It is gradually becoming a practice that these internal expenses and disbursements are borne by the firm and not clients. This changes the whole dynamic of managing expenses. The firm has to suitably factor these expenses and other overhead into what it charges to clients on an ongoing basis, so that overhead cost is recovered and the firm doesn’t keep draining its own cash resources for client expenses.
Proper internal procedure and operational control are needed to ensure that the recovery from clients is made on actual costs. It is important to keep the billing team informed of all such costs incurred by the firm. Further, it is the duty of the firm’s administrator to minimize such costs, and assist the firm in saving expenses for itself and its clients by comparing the in-house vs. outsourcing costs of items such as printing and copying.
Expenditures incurred by the firm with regards to airfares, hotels, taxi, court fees, notary, and registration fees, etc. should be reimbursed by the client as soon as possible. It should be a regular practice of the firm to have the client pay directly for the expenses wherever possible, as it decreases the load on the cash flow of the firm and also reduces administrative hassles of recording such payments and transfers.
One of the most important aspects of cash flow management is the swap between benefits and cost of liquidity. To increase cash flow and ensure the firm’s liquidity is not adversely affected, it is of utmost importance that the collection and disbursement of cash are properly timed and handled efficiently. A careful cost and benefits analysis of the firm’s credit policy should be exercised before making decisions pertaining to trade discounts or to delay outstanding payments.
When required, cash flow can be adjusted by ensuring that outstanding bills are not cleared until due. Clearing invoices before they are due, as practiced by some law firms, leads to a cash crunch at a later stage. A reasonable and sufficient gap can be created between credit periods allowed to clients and credit period provided by suppliers if careful and wise planning is done by the finance team in advance.
The Art of Maintaining Recoveries without Disrupting Client Relationships
Maintaining healthy relationships with clients and ensuring timely recoveries at the same time is a big challenge faced by most law firms. The senior management and attorneys at the firm face a dilemma of approaching clients to recover fees due, as it may ruin their long-lasting relationship over financial matters.
Usually, the responsibility of exercising timely recoveries lies with the finance department of the firm. Partners and team leaders should be kept updated with the outstanding dues and collection on a monthly basis. A list of outstanding fees and unbilled transactions including the expired deadlines should be circulated to each partner. In a situation where the unbilled amount exceeds a certain limit, the firm’s finance head should personally discuss it with the concerned partner and suggest immediate follow-up with the client. To properly motivate the partners to ensure timely recovery and follow-up on bills, partner compensation can be linked to recoveries of the firm.
Right-timing is everything, and it makes a huge difference in the end. Partners should understand the most favorable time to convert receivables into recoveries. Partners would know when it is likely that a client would pay for services without resistance or delay. When you have drafted an important contract or when you have a key motion in court or have closed a negotiation in the client’s favor, the client sits at the top of the client satisfaction curve. This is the right time to ask for payment, and chances of successful recovery are very high.
Subject to the availability of resources, a law firm can outsource the whole process of recovery and collection to industry professionals. When recoveries are executed under the supervision of partners, it results in faster recoveries, increasing the cash flow.
To sum up, contrary to the common understating, cash flow and profitability are two different concepts of financial management, often mistaken as synonymous. A layman’s understanding of profit is that the owners take the profits home. In truth, however, in order to grow the business, profits are largely used to pay taxes and are often pulled back into the firm, for example, to upgrade the internal infrastructure, equipment, and technology. On the other hand, perennial cash flows are required to pay day-to-day expenses, such as salary and administrative expenses. Cash flows are necessary to run a business even before the firm generates revenue.
Law firm statements of profit & loss do not reflect the true importance of cash flow, as the primary purpose of these statements is to show income and expenditure for tax purposes. Cash flows are the result of the firm’s net income and are subject to fluctuation as the balance sheet changes. For instance, transactions related to purchase of assets, loan repayment, etc. are not reflected in the profit and loss statement, but they have a significant impact on the available cash. Events like a purchase of assets affect the disposable cash available with the firm.
Cash flow forecasting and annual budgeting are important exercises that can help a firm in planning the timing of such events and avoid cash flow emergencies. For instance, if a firm that is heavily dependent on revenues through contentious matters is aware that no court hearings are lined up for particular months, or courts will be closed during certain months, it can predict that revenues for those months will be low, and so large purchases should be avoided. A vigilant study of the application of funds in the cash flow statement should be done from year to year to notice trends.
The growth of a firm is dependent as much on the cash flows as it is on profitability. The best practices mentioned above are widely recognized and have already implemented by many law firms. The results are largely positive, and adopting these best practices ensures better performance and growth of the firm. The attorneys can focus on the bigger picture, and leave the management of financial aspect to operational checks and balances. These systems and controls of financial planning exist to assist you and lower your burden in the fast-paced competitive environment.
About the Authors
Bithika Anand (left) is a principal and Nipun Bhatia (right) is an affiliate consultant with Edge International in India. Ms. Anand also is founder and CEO of Legal League Consulting, India’s first management consulting company for the legal industry.