Make More Rain : operations, cash flow issues

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

Associate Salary Increases & Firm Margins

Admin — Thu, 04 Sep 2008 17:20:23 GMT

It should come as no surprise to anyone that the most recent wave of associate salary increases have helped to erode law firm profit margins. Whether the wave begins in west coast technology firms, or east coast financial capital firms, its effects are felt beyond big law in the mid-size and regional firms headquartered in the mid-west and southeast. And, with 80% of law firm expense tied up in compensation and occupancy, the impact can be devastating. What is more surprising is the response of law firm leaders in this new economic environment. Reactions run the gamut from slash and burn tactics to taking it on the chin and silently watching margins erode. Formulating a balanced strategy and resisting the urge for an emotional response is critical. Consider the following.

First, is increasing associate salaries is an appropriate response to increased competition for the best talent in your market or just a follow the leader reaction? Associate salary increases typically begin in markets where competition is fierce for not only attracting the best talent, but also keeping that talent as the reality of billable hours requirements hits home. Increasingly, associates are not willing to trade work life balance for a big paycheck. This attitude is not pigeonholed in the bottom half of the law school classes, but pervades throughout. Are there other work life benefits your firm can offer to entice top talent?

Secondly, recent surveys suggest the demand for legal services have declined in the first two quarters of 2008, and making sure your lawyers are properly utilized is essential to maintaining profitability. As margins become slimmer, there is no room for unproductive associates taking up space. But are associates really the problem? Most associates have little control over the projects they are assigned and virtually no ability to generate new business. They, like everyone else in the firm, rely on the rainmakers to generate enough billable hours to support the business. Before taking a defensive posture and eliminating positions, look for ways to improve your business development efforts. Are you effectively cross-selling your services to existing clients? Do you place enough emphasis on developing new business and in the right sectors?

Lastly, in today’s competitive marketplace, passing increased costs on to your clients is rarely an option. Even in big law, where clients were thought to be less price sensitive, general counsels are scoffing at increased rates as a result of higher associate salaries. Can you blame them? That doesn’t mean you have lost the ability to control your average rates. The next time someone asks you for an alternative billing arrangement, consider the request an opportunity to control your own destiny. Look for ways to strengthen the value proposition, improve practice management at the matter level, and increase leverage.

Can you avoid the impact of associate salary increases? Not likely. But focusing on the positive economic aspects of your business, rather than going on the defensive, may help you roll through the downturn and leave you prepared for the eventual upswing.

- Rick Rawls

Managing Partner Advocate Summer Issue In The Mail

Admin — Mon, 30 Jun 2008 23:30:57 GMT

The summer issue of the Managing Partner Advocate is now in the mail. This issue is focused on ways to combat the effects of a contracting economy. Highlights include retaining talent, managing associates, planning for the unexpected, measuring marketing activity and measuring timekeeper profitability. There is also a guide to minimizing facilities costs written by guest author Luke Raimondo, an attorney and commercial real estate broker, and a guide on how much debt a law firm should carry.

The summer issue provides excellent guidance for law firms to help improve profitability even as the GDP struggles to grow. If you are a subscriber to the site, you may download the summer issue by clicking here. You may also have the advocate mailed to you at no cost by clicking here and requesting a subscription.

It is with great regret that I am leaving LexisNexis and will no longer be associated with the Managing Partner Advocate and More Partner Income. I took over the blog from Tom Collins in January of this year, a mere 6 months ago. In that time I have moved the site to a new host, completely re-built the blog and have enjoyed record numbers of readers, building on the solid foundation Tom Collins built over the past 3 years. I sincerely appreciate all of you who have read this blog and utilized it as a resource to help your firm.

This is my last post as editor of this blog. I have enjoyed my brief time hosting More Partner Income and hope that you have found value in the posts I have written.

Valuing Your Firm's Inventory

Admin — Fri, 27 Jun 2008 17:16:24 GMT

Most law firms understand intuitively that the value of inventory (both WIP and A/R) degrades over time, but by how much and how quickly? The ability to understand and answer these two questions is the first step in preparing a realistic, forward looking valuation model; one that can identify opportunities and drive action, rather than simply report on past performance.

To begin to answer the question of the future value of current inventory, it is important to realize there are two different forces diminishing a firm’s return on work performed, and both have the same basis: time. In essence the old adage “Time is Money” is true; as time passes, your inventory becomes less valuable.

The first and most basic of the two forces is widely known and easily calculated. For our purposes, we will call it the Time Value of Money effect, or TVM. A dollar today is worth more than a dollar tomorrow. Anyone who has ever used a credit card, carried a mortgage, or borrowed or lent money in any fashion, understands this concept. However, many law firms simply disregard this as a cost against their inventory, or use such a low discount rate, as to make it negligible. When considering a firm’s discount rate, too often factors such as reasonable market expectations of returns and inflation are swept aside. In the model below we use a simple method (with two different Discount Rates) to determine the cost of time on a firm’s inventory: Amount X Daily Discount Rate X Open Days; where the Daily Discount Rate = Yearly Discount Rate/365 days.

The second, and in most cases much larger charge to your inventory, is what we will call the risk of default (this refers to both defaulting on receivables and not billing work in progress). This is the risk that a firm will not realize a portion, or the entirety, of the value of work performed. In most cases it is instinctively understood that receivables a year old are far less likely to be realized than those just billed. The same can be said for WIP. But how do we measure this concept? One possible way (and there are many) is to use available historical billing and payment patterns to develop a forward expectation curve. We can then apply this curve to our current inventory to determine the amount that is realistically likely to bill or collect. This method can be made more complex or simple depending on various assumptions and the level at which the expectation curve is developed to (i.e. practice group, type of work, client, etc) but the concept remains the same -- past performance is an indication of future performance.

In the example below, such a curve is constructed for a client based on a set period of time and then applied to four matters with outstanding A/R (a similar model can be built for the WIP side). A total of $200,000 has been billed over the life of this client, with $175,000 eventually being realized (or 87.5% seen at day 0). As might be expected, the majority of the collections (> 50%) have historically taken place within the first 90 days. The Fwd A/R Expectation Curve helps quantify the expectation of collection (or non-collection) as current A/R ages based on prior practices (i.e. at 240 days, $50,000 has been available to collect, but only $25,000 has been collected, giving us a historical realization expectation of 50%; therefore, if current A/R now ages to 240 days, we would expect to realize 50% and lose 50%). Of course, like any forecast, our model will not be 100% correct at each level of granularity, but it does provide a logical, and historically proven, method to value inventory, particularly at the firm level.

While simplified, the models above allow us a better understanding of a) how much of the work we have currently performed we expect to realize and b) the actual value of that work once we do realize it. Any questions, concerns, or comments on the above can be directed to Dschutz@redwoodanalytics.com.

Forecasting Collections and Inventory Management

Admin — Thu, 12 Jun 2008 07:00:51 GMT

In today’s unstable environment, driven by outside economic forces, higher associate salaries, and increased competition, law firm leaders are faced with the tough job of forecasting cash collections. Many existing forecast methodologies focus on production and collection realization. However, these models often fall short because they ignore the other drivers of collections, and do not provide any information about collections beyond the forecast period. A better model:

1) Forecasts bills and collections as they relate to inventory levels thus allowing analysis into the impact of the next period’s collection funnel,

2) Drives the forecast according to the speed of the billing and collection cycle,

3) Isolates the quality of inventory separate from collection timing by analyzing realizations at the time of collection.

A key aspect to understanding collections is to think of the process as an inventory funnel. Each month production is added to the funnel, increasing inventory available to bill and collect. At the same time, bills and collections, as well as write downs and write offs drain the funnel, thus reducing inventory levels available next period. By analyzing this inventory turnover, modelers can focus on the drivers of collections: beginning inventory, production, inventory turnover, and realizations. Consider the following example:

	Last Year		Forecast
Beginning Inventory	$50,000		$60,000
Production	$150,000		$170,000
Total Available for Collection	$200,000		$230,000
Written down/off	$10,000		$11,000
Cash Collected	$130,000		$150,000	(3)
Inventory Turnover	$140,000		$161,000	(4)
Ending Inventory	$60,000		$69,000

Inventory Turnover %	70%	(1)
Realization %	93%	(2)

1) Inventory Turnover/Total Available for Collection

2) Cash Collected/Inventory Turnover

3) Total Available for Collection * Last Year’s Inventory Turnover %

4) Inventory Turnover * Last Year’s Realization %

In this model, the total available for collection is beginning inventory plus production. By comparing the amount available for collection and the ending inventory, the modeler may derive the inventory turnover. Also, by looking at the type of turnover, collected vs. written down or off, the modeler can calculate realization. Applying Inventory Turnover % and Realization % to future inventory, produces a cash collected forecast based on all of the cash drivers mentioned above and provides a starting point for the next period.

Redwood Analytics has helped law firms forecast collections using this and other methodologies since its inception. Our Business of Law Consultants are prepared to help law firm leaders take their forecasting to the next level by sharing best practices forecasting techniques, separating inventory turnover for billing and collection cycles, and capturing the seasonality of collections. In addition, our business intelligence solution is uniquely positioned to help law firms not only improve their forecast, but also their actual results.

Measuring Your Law Firm's Billing Cycle

Admin — Fri, 25 Apr 2008 07:00:14 GMT

One of the observations in the 2007 Law Firm Economic Survey by LexisNexis and a focus of the 2008 Survey (in progress) relates to cash flow. According to the 2007 Survey, all firms had a slow billing cycle. On average it took firms 170 days from providing a service to collecting payment on it. In non-service industries that would be a recipe for bankruptcy. Law firms enjoy high margins, so once the firm initially weathers the 80 or so days before the cash starts coming in, it can survive the slow cycle. Unless the cycle stops.

How will you know when clients stop paying? How long do you have until your cash flow reduces to a trickle? Measuring your billing cycle times is critical in answering these questions.

Long billing cycles hide what may be slowly killing your firm - inefficiencies, declining business, etc. If you aren't measuring your performance in converting work to cash, you may not know that your firm is in a crisis for several months, wasting valuable time to act.

Below is an example chart that shows how you can measure the billing cycle by just tracking your unbilled fees, billed fees, and collected fees.

To determine unbilled fees, take your work in process that is currently unbilled and not subject to mark-down (to the extent known) for the prior "rolling" 12 months. Do the same for fees billed and fees collected. From that you can determine your average days to bill, days to pay and average AR days fees outstanding. Lowering any of these numbers will increase cash flow and provide additional liquidity to the firm.

The above takes a look at the billing cycle from the firm perspective. You can also do this analysis on a timekeeper or practice area. Tools such as Juris' Active Information can not only track your billing cycle but can also drill down into the "why", exposing inefficiencies that are hampering your ability to maintain liquidity and giving you an opportunity to act to increase cash flow before it slows.

Click on the graphic above to download a spreadsheet to use with your firm's numbers. You must be a registered user to download content.

The Long Tail and Legal Services

Admin — Fri, 25 Aug 2006 17:00:00 GMT

I finished reading Chris Anderson’s The Long Tail while flying to ILTA’06 this past weekend. I have to admit that I apparently don’t have the imagination to envision how the Long Tail theory will ultimately transform the business of legal services or even to conclude that it will.

Nevertheless, some of the transformations in the operating environment that give rise to the Long Tail economic theory have already begun to change the prospects of small and midsized firms.

Consider Carolyn Elefant’s recent post on MYShingle, You Can Take It [Biglaw Practice] With You. Elefant’s post signals a shift. Technology, communications and the Web are weakening the big firm hold on high-valued specialties. Because prospective clients (worldwide) can now find you easily, even large corporations are starting to shop for niche players in legal specialties.

For more about the Long Tail theory or to purchase Anderson’s book, visit his Web site, thelongtail.com.

Morepartnerincome.com is sponsored by Juris, Inc. For information about Juris® products and services for increasing law firm performance and partner income, go to www.Juris.com.

2006 Technology Survey of Law Firms

Admin — Thu, 24 Aug 2006 17:15:43 GMT

Exhibiting vendors at the Orlando Annual Educational Conference of ILTA, International Legal Technology Association, received a private briefing from the association. Representatives from Envision Agency reviewed results from the 2006 Technology Purchasing Survey conducted on behalf of ILTA.

There are some pretty remarkable insights. First, it is important to note that the survey respondents are members of ILTA. Thus, for the most part, those responding are non-attorney technology heads of their firm—CTOs, CIOs, and technology managers and directors.

What do these law firm technology leaders think are the most exciting technology or trends?

Microsoft® SharePoint®
VoIP (Voice over Internet Protocol)
VM ware (Virtual Machines)
KM (Knowledge Management)
Portals
Wireless
Matter Centricity

Besides hardware (workstations, notebooks, etc.), what tops the buying wish list for 2006?

Disaster recovery-related programs
Document and record management
E-mail management
Scanning
Litigation support
Internet/intranet/extranet
Microsoft® upgrades
Workflow automation
Phone system—VoIP

One notable item is a significant decline in the number of firms looking to implement wireless technology and devices. The decline reflects a universe where wireless technology is now widely implemented by law firms. In short, if you are not wireless, you are now behind the curve.

While Business Intelligence Software and Customer Relationship Management software (BI and CRM) are not at the top of the list, they still appear to be priorities. Likewise, business systems (accounting, bill auditing, and budgeting) viewed collectively would make the top of the list. Business systems like Juris® are also crossing over into business intelligence, which would place plans for new investments in law firm business software even higher on the list.

If you are wondering what to read to keep up with law firm technology, the most popular legal/technology publications among ILTA members were:

Peer to Peer (The association’s publication)

Interestingly, technology leaders do not appear to be big blog readers. Here is the list of Blogs that showed up on their “Yes, I read” list:

Law Firms Concerned With Technology Join ILTA

Admin — Wed, 23 Aug 2006 17:17:32 GMT

When it comes to law firm technology, The International Legal Technology Association (ILTA), is the group to belong to.

I flew to Orlando this weekend for ILTA06, this year’s annual education conference. You do not see a lot a technology partners at an ILTA conference (at least, not yet). That doesn’t make it any less important for the firm to be a member of ILTA. This is where the rubber meets the road when it comes to law firm technology. This conference is about the nuts and bolts of law firm technology. This is really the only place where your key IT executives, directors, and managers can stay abreast of the ever-changing technical, strategic, and management issues related to the use of technology in law firms. To see firsthand the depth of the curriculum, review the sessions scheduled for this year’s conference.

Over 800 law firms are members of ILTA. Membership is firm wide and dues range from $500 to $900 per firm, depending on size.

For more about this year’s conference, visit the conference web site. You can find out more about the Association and apply for firm membership by going to http://www.iltanet.org.

Morepartnerincome.com is sponsored by Juris, Inc. For information about Juris® products and services for increasing law firm performance and partner income, go to www.Juris.com.