Make More Rain : cash flow issues, policies/ procedures

Why the Year End Collection Push is Not a Best Practice

Admin — Tue, 09 Sep 2008 16:38:57 GMT

It is that time of year again, at least for the early starters, when the legal industry begins its preparations for the year end collection push. The push has become an industry standard and buzz word over time. Each year countless hours are put into collecting massive amounts of receivables every December in order to meet targeted numbers. Although it is a foregone conclusion that there will be a year end push for most law firms, is this really a best practice?

The “ideal” approach with respect to legal industry inventory management is to have a continual billing and collections push year round, so everyone can enjoy the holiday season without worrying about making a budgeted target for collections. Although ideal, given the history of the industry, this is unfortunately a practice that will take time to implement. Even if that happens, the remains of the year end push might still have legs. For most firms both lawyers and, more importantly, their clients are used to and expect a year end push. It is a behavioral pattern that is established and therefore not going away anytime soon. That said there are negative ramifications to such a practice and a few firms have recognized this and smoothed out their collection pattern.

Client Behavior

The first obvious detriment to a year end collection push is the impact on client behavior. If clients expect a year end collection push then they are less apt to pay within a consistent, timely manner. Some clients even have said to relationship attorneys who have tried to smooth out the process, “Why pay now if I know you are just going to look for more in December.” In fairness to the client I would probably hold on until December as well. For example, if my mortgage company let me pay all of my mortgage payments in December, I would do so - which brings me to my next detriment of the push, the Time Value of Money impact.

Time Value of Money

A dollar today is worth more than a dollar tomorrow, so everyday a firm does not collect on a receivable they are foregoing the opportunity of re-investment. In my previous mortgage company example, I would take all of the money I owe the mortgage company invest it in some sort of portfolio that would give me a return on that money which would go straight to my pocket instead of the mortgage company. That is the same thing that occurs with the year end collection push within the legal industry: Investment income is left on the table as receivables age.

Aging Inventory

The next 2 problems are more internally focused within each firm. Not only can the collections push can have a negative impact on client behavior, it can as well with attorneys . A colleague of mine wrote a blog back in June on “Valuing your Firm’s Inventory” which I encourage everyone to read as it outlines how, as receivables age, the likelihood of realizing the original amount of those receivables diminishes. Since attorneys also exhibit the behavior of letting work age before it is billed, and billings age before they are collected, the probability of billing or collecting the original work/bill amount goes down.

Other obvious detriments include the ability to know where you are to your budgeted numbers as the year goes along, and how to budget for next year given a lack of information on your collections; a final drawback of the year end collection push is the impact on the age of your inventory. In the graph below, you can see three years worth of inventory pushes. There is a significant drop in balance each December (as depicted in the bar graph), but you can also see a spike in the age of inventory. Why does this occur?

I ask many of the firms I work with and they almost always point to the answer: At year end, with pressure to make budgeted goals, most of the collection effort is on receivables that firms know they can collect and are more recent in nature. Therefore, the older inventory that has been aging over the years continues to get older and may get to a point where it is completely uncollectable. This is an unfortunate side effect of the collection push and one that should be accounted for in any inventory management strategy.

Although I have gone over many reasons why the year end collection push is not a best practice, I am not blind to the fact that it is not easy to make a quick switch to a continual inventory management process. So given that the “ideal” practice is not a readily accessible current option, are there things firms can do to prepare and approach the year end billing and collection push to try to maximize its result while working on the before mentioned strategy shift ? The first suggestion is start billing early –nothing earth shattering. With most firms you see an upward trend in periodic billings in October and November. That trend should start in the 3^rd quarter, and those firms that have a more gradual collection slope in the last few months also have an increased slope in billings from August until November. The easy explanation to this is that billing is a more controllable portion of the inventory cycle than its counterpart. In the example below, you can see such steep a slope in each of the prior 2 year end pushes where as in the last year that billing was much more gradual and steady as the end of the year approached.

The natural benefit is that by getting the built up WIP out the door in a timely manner will give you the ability to focus on collections for a longer period.

The firms that I have worked with who have had the most success with respect to WIP management are those that have some stipulation on billing in a timely manner when it comes to their partner compensation. Knowing that many firms cannot simply switch their compensation system on a dime, this type of action is not widespread, but it is a proven method. Each firm has seen an improvement in inventory management when a portion of partner compensation has been tied to that driver. “Compensation” in this regard can be defined as a direct input into the partner compensation equation or, alternately, can equate to monetary “fines” for late billing and/or collections.

It may be inevitable within current industry conditions that December will be the month with the most collections. Again, it is in the best interest of the firm to change the status quo and begin collecting earlier and in a timely manner. Not only will you be able to have a better idea of where you will stand to budget sooner, but it will set your firm up for budgeting the next year. Still, if focus can be put on opportunity balances (those that have aged past an expected pay time) early in the process it may help avoid the side effect of the ever aging inventory. Those older balances can have the focus early on and perhaps generate collections while in December the focus can shift to the more readily available receivables.

I certainly hope that as time goes along the year end collection push will lose its luster as a buzz word and be replaced with continual inventory management. At the end of the year the firms that take this to heart just may see increased realizations, additional investment income, and perhaps most importantly a little more piece of mind that you are on target and can enjoy the holiday season.

- Posted by Russ Haskin

It Is Time to Turn Up the Heat on Billing Attorneys

Admin — Mon, 10 Sep 2007 17:20:29 GMT

Labor Day marks the end of summer, and with its passing managing partners begin thinking about end of year issues.

It is time to turn up the heat on billing attorneys. Ideally, the firm remained focused on billing and collection efficiency throughout the year. Unfortunately, I know from experience that law firms (especially non-AmLaw 200 firms) tend to let work-in-process and accounts receivable accumulate during the year. As year end nears and partner distributions become threatened, unbilled worked that has been wasting away in the firm’s inventory finally get billed. Likewise, partners start chasing delinquent bills with determined effort.

Don’t wait any longer. Take steps now that will encourage partners to clean up old work-in-process and collect past due bills. Circulate a weekly aging report by billing attorney of both unbilled items and uncollected billed items. The comparison by billing attorney puts peer pressure on your side. At month end, you will also want to compare the current amounts to the amounts as of the end of the prior year. The difference will help bring home to partners the extent of billing and collection work that needs to be done. It is also helpful to hammer home that the increase in WIP and AR over prior year-end amounts is money that will not be available for partner distributions unless billing attorneys get busy and reduce funds they have let sit idle—unbilled and/or uncollected.

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Cash Is an Unreliable Barometer of Law Firm Health

Admin — Tue, 23 May 2006 17:32:00 GMT

I often talk about law firms that are accidentally successful. That is a term I borrowed from Debbie Foster, president of Intouch Legal. At least Debbie is the first person I know that used the term.

Accidentally successful law firms are running on autopilot. As long as there is money in the bank account, everything must be okay. The trouble is the bank account is a lagging indicator for a law firm. When it goes amiss, it is usually too late to do anything about the problem. Consider the following graphic:

For the average law firm, there is a 4 ½-month lag between the time billable services are rendered and the date that the client’s check gets deposited in the law firm’s bank account. The above simple graphic doesn’t tell the whole story. The pipe has holes in it. “Would be” cash leaks through those pipe holes as write-offs, adjustments, and bad debts. The longer the pipe, the more "would be" cash is wasted.

Given the lag time, a train wreck can be just ahead and the accidentally successful law firm will not have a hint that it’s coming. The partners will miss the opportunity to take corrective action. They will miss the opportunity to take steps to reduce costs or secure access to additional funds. In short, 4 ½ months after the cause, they wake up and find the coffers empty.

Neither unbilled fees nor fees receivable appear on the typical Cash basis balance sheet of mid-sized firms. But it is essential that they be tracked and managed.

That is not enough. You need to take another important step. To avoid the perils of an accidentally successful law firm, managing partners need a forward-looking system that forecasts cash flow months into the future. The key to a workable forecast is not to get too complex. A law firm is a relatively simple business, and if you understand your particular firm’s key operating metrics, building a workable model is not too difficult. It is important to update your forecast monthly.

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General Counsels Have a Budget Problem

Admin — Fri, 15 Jul 2005 17:57:00 GMT

Solving the General Counsel’s Budget Problem

Nat Slavin who writes the "Interactions" section in Corporate Legal Times often hits the mark. Sometimes, it is with a curve ball. His July article is about bid fixing—the increased frequency of general counsels asking law firms to rebid their work to retain the corporation’s future business. Why? It is because the corporate world lives by a budget. Law departments, once exempt from budgetary discipline, are now expected to deliver on target like any other cost center.

That discussion turns into the observation of the root cause for bid fixing. Slavin observes that law firms are failing to address their client’s economic needs.

On average, law firms take 78 days to bill for work performed and another 60 days passes before the client pays for work performed. Under those conditions, law departments cannot realistically budget or forecast future expenditures. In short, law firm fees are eight months behind actual performance of the legal work performed on behalf of the client.

Don’t think your corporate clients place any value on the free cash float. They don’t. In fact, they don’t understand how anyone would do business that way; and second, it often results in a blown budget, putting general counsel in a bad light with the company’s CEO.

Slavin puts it this way, “Until law firms start billing in advance of the legal work they provide, businesspeople will never be able to bridge the gap between budgeting and actual expenses.”

The author points out that law firms should be able to predict 90 days out and bill that amount. It is a risk firms should be willing to take to reduce the tension between the client’s legal department and the company’s CFO.

For the complete article, refer to the July issue of Corporate Legal Times. If you would like to comment or pass along your experiences to the author, e-mail Nat Slavin at nat@cltmag.com.

Pricing pressures in the corporate world may be more about uncertainty than price itself. Solving that problem for the general counsel can reverse recent trends and actually increase realization and per-partner income.