Cash Flow: How to Get it, How to Keep It

Reprinted from:
By Ed Poll, March 2011

If your outflow exceeds your income, the upshot is your downfall. This lesson is hard for lawyers to grasp because they too often equate financial success with hours billed out rather than cash realized in.

If your outflow exceeds your income, the upshot is your downfall. This lesson is hard for lawyers to grasp because they too often equate financial success with hours billed out rather than cash realized in. Any lawyer’s inventory is not billable hours – it is the amount of cash that is realized from the billable hours outstanding. Realization is simply the percentage of what is billed that is actually collected. For example, a lawyer who bills $150,000 in a given month but collects only $90,000 has a realization rate of 60 percent. In any business, collecting 60 cents on the dollar will cause financial disaster.

Realization exists in two levels: Percent of billable or booked hours billed (worked-to-billed ratio), and percent of billed work collected (collected-to-billed ratio). The goal is to have a high collected-to-billable ratio. An overall realization rate of less than 85 percent is unacceptable. To estimate the progress of realization, use the accounting measure of turnover ratio: accounts receivable balance divided by billings per days in the billing period. The turnover ratio tells a lawyer to expect payment for billings X number of days after a client receives a statement. The national average for law firms, according to past surveys, is often as much as 120 days, sometimes more.

Do not let turnover get that high. Lawyers can control cash flow through effective cash management to a greater degree than they usually believe is possible. The key to doing so is to follow five fundamental rules for cash flow optimization.

Rule One: Define cash terms

Before settling on the fee a firm wants to charge for a matter, it should obtain as much information as possible about the goals and expectations of the client. Information should cover parties, issues, anticipated strategies and desired outcomes.

Understanding the client’s objectives is essential to defining the payment obligations for the engagement. Getting fees and payment terms in writing is at the heart of the engagement agreement. That means getting the client’s written agreement regarding the fee to be charged and how it will be calculated, when the fee is to be paid, and the consequences of non-payment. When the client understands what to expect, collections success increases significantly.

This is particularly true when accompanied by the client’s acceptance of a budget that addresses events, time and anticipated fees. The engagement agreement should state explicitly that the lawyer will stay in continual touch with the client about expenses versus budget. The two crucial budget parameters are time (a common sense estimate that errs on the side of caution) and money (which should reflect what a client wants to spend as much, if not more, than what a lawyer thinks will need to be spent). Once the client formally approves the final budget, all subsequent communication about it must be a collaborative effort. The budget document should be periodically reviewed, with clients being told how much they have already spent and being asked to approve any necessary changes.

Rule Two: Specify cash collection

Because the engagement agreement is the foundation for all future fee and collection considerations, never hesitate to be as detailed as possible in the terms spelled out. To prevent collection problems, set a written fee agreement that removes any uncertainty about what is to be paid, and specify the collection cycle that defines the day of the month by which it is to be paid. With the terms established, bill in a regular and timely way, using statements that contain a full narrative of the work done and the goal accomplished by that work. The more information that the invoice provides about what was done and what that work accomplished, the more likely the client will be to perceive the bill as fair and to pay it promptly.

Too many lawyers make the mistake of brevity when billing – for example, "worked on motion for summary judgment, 20 hours." Break any such charge into its basic elements, with the amount of time needed for each: review key documents and deposition testimony, draft statement of uncontested facts as required by court procedure, research precedents in four similar cases, and so on. Such itemization does not try clients’ patience – it helps them understand just how much was done on their behalf. Use action verbs to describe services and clearly indicate the specifics of what was accomplished. This gives clients an appreciation of the effort required for success.

Rule Three: Enforce cash payment

Lawyers should resist discounting their fees – particularly if the client has earlier agreed to pay the full amount in the engagement agreement. Clients who argue about over-billing often just want a discounted bill. Such tactics are quite popular with clients during the month of December. They agree to pay their large bills in order to wrangle discounts because they know the remuneration system for partners is based upon how much has been collected by the end of the year. Any bills collected in January do not count for another 11 months. Some clients attempt to discount their lawyers' fees for every matter. Even worse is when law firms themselves propose the discount. Often on accounts for repeat clients with significant billings, the firm in its year-end push to collect fees will offer some type of discount.

Even clients with a signed fee agreement soon decide not to pay without a discount. They wait until the end of the year and know they will receive a discount at that time. The most practical way to prevent this is for the firm to refuse to offer the discount in December, telling clients that there is a fee agreement in place and it will be enforced – irrespective of the firm’s failure to enforce it in the past. The worst case scenario is underscored by Chapter XII of the Code of Professional Conduct: "Failure on the part of the client after reasonable notice to provide funds on account of disbursements or fees will justify withdrawal by the lawyer unless serious prejudice to the client would result." That latter caveat alone indicates it is best not to let things reach this point.

Rule Four: Pursue cash non-payment

When there is an overdue account, there should be a consistent approach to connect with the client. Make sure the bill is received and, if it has been, ascertain whether the client is dissatisfied. Large and small firms alike often continue to work for the non-paying client in the misguided hope that continuing the relationship means getting paid and receiving referrals in the future. However, clients respect firmness and a businesslike approach, and generally do not go out of their way for lawyers they disrespect.

To maintain respect, the lawyer should not be the collection agent. The best practice is for the firm’s payables staff to request payment. If necessary, use a collection service. There are certainly ethical snares involved, but they can be avoided by disclosing to the service only those details that are absolutely necessary for them to do their job without jeopardizing client confidentiality. Moreover, it is a given that a collection effort should be made only after a review of the client file to make sure that it contains no basis for a malpractice allegation.

Rule Five: Make cash work

Once you have the client’s money in hand, the final rule of cash management is, never wait to deposit it, particularly if payment is by check. Otherwise, too many problems can happen: the client may become angry and stop payment, or have insufficient funds when the check is finally presented for clearance, or become party to a lawsuit or other proceeding in which financial assets are attached. Immediate deposit also helps maintain a high average daily balance, which is one of the most significant bits of information a bank uses in analyzing a loan request. You can keep funds in the account longer by depositing revenue immediately upon receipt and spreading the payment of bills throughout the month. Do not pay your bills all at one time: This will cause an exaggerated dip in your account balance.

Getting credit from a banker today means documenting clear plans for cash and receivables management, as well as for marketing and business growth. With credit markets continuing to be tight, managing cash is your number one consideration for firm survival. Even if you can get bank financing, by far the best assurance is to have built up an adequate cushion of savings to cover worst-case scenarios in the collection and payment cycle. Without consistent and effective cash management and collection efforts, your outstanding receivables constitute a no-cost loan to the client. Just as a bank will not carry you in the hope that you will pay on an outstanding loan, it makes no sense for you to do the same thing with your clients on a vague hope of being paid as expenses pile up. We end as we began: if your outflow exceeds your income, the upshot is your downfall.

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