This is the first in a new series of guest blogs contributed by some of the many partners that we work with at katchr. The criteria for our guest bloggers are simple – they are people who we believe have something interesting to say about law firm management.
The first is from Andy Poole of Armstrong Watson, who shares his practical ideas on exactly how to manage cashflow in a law firm, and not surprisingly these require having access to the right data to measure performance.
I hope you enjoy these contributions.
Planning for positive cash flow
Profitability levels may have improved for many law firms, but cash flow remains stubbornly difficult to pick up. This is likely to continue, particularly for those firms that are fortunate enough to be part of an expanding market.
As activity levels increase, staffing and other expense requirements grow. Those expense payments are required to be paid as work is performed, yet the law firm will typically not receive payment until it has performed the work, raised the bill and then waited for clients to stump up the cash. The period between performing the work and raising a bill is known as WIP days; the period between raising the bill and getting paid is known as debtor days. Collectively WIP days and debtor days comprise the lock-up period – the amount of time that cash is locked in the system. It also reflects the working capital requirements of the business, which will grow as activity increases given that increasing expenses need to be paid the whole lock-up period before the firm will benefit from the increased receipts.
So, how can firms manage the cash flow challenge? One way is to ensure that the business is appropriately funded. Firms do require a certain amount of working capital funding which tends to be raised as a mixture of bank funding, specialist lender funding and partner capital injection; the latter of which may also be borrowed. Funders will want to see partners having some skin in the game, but more importantly that they have a well-managed business with realistic forecasts demonstrating an ability to repay the funding under a range of circumstances.
The starting point for planning for positive cash flow therefore needs to be the preparation of detailed financial forecasts that demonstrate the anticipated cash flow, together with the potential impacts of various potential outcomes. Those forecasts should be fully integrated with a balance sheet, profit and loss account and a funds flow statement. They should include detailed assumptions and thoughts behind the numbers and they should be used to manage the business on an ongoing basis.
The forecasts should allow law firm leaders to identify the points at which cash flow may be tight and permit appropriate decisions to be made in advance.
Debtor days and WIP days by fee earner should be analysed to allow accurate forecasts to be prepared. Both should also be monitored on at least a monthly basis as part of the ongoing management of law firms. Those periods will vary widely by work type, but in general if average debtor days for the firm exceed 60 and/or average WIP days for the firm exceed 90, then the working capital requirements for the firm will be higher than the averages for a firm with a well balanced mix of work types.
Realistic lock-up targets should be set by fee earner, taking into account their role and work type. Those fee earners not only need to be aware of those targets, but also how they can regularly access the information for self-management; why they are being monitored and targeted; and the implications of their day to day activities on the lock-up period – i.e. how they can improve matters. Financial education is therefore an imperative, but crucially education designed to allow fee earners to become more comfortable in having difficult financial conversations with clients that not only maximise cash flow but also maximise client relationships. Our in-house training courses for law firms outline how it is possible to do both.
My top 10 pointers for maximising cash flow are:
- Preparing realistic forecasts
- Obtaining a suitable funding mix
- Analysing, targeting and monitoring debtor days and WIP days by fee earner
- Providing in-house training courses for all partners and staff on understanding finance in law firms
- Resisting the temptation to recruit too many staff too early – sweat your assets appropriately
- Clearly agreeing the fee basis – or better still the exact fees – and the timing of work and payments at the outset of all new instructions
- Agreeing with clients that interim bills will be raised on at least a monthly basis – then reviewing WIP prints on a monthly basis for all potential bills, however small
- Raising the final bill promptly on completion
- Raising monthly bills no later than the 22nd of each month so that they are received by clients before the end of the month and may therefore hit their payment runs a whole month earlier
- Empowering the credit control function and preventing fee earners from unnecessarily blocking the credit control process
The same principles apply whether your law firm is expanding and seeking to maximise cash flow to restrict the growth of working capital requirements or whether your firm is not so fortunate to be growing and needs to maximise cash flow to stabilise the business. Either way, law firm leaders will need to take hold of cash flow management in 2016 or risk going the same way as the firms that have sadly run out of cash and perished in 2015.
This article was first published by Solicitors Journal www.solicitorsjournal.com on 02/02/16, and is reproduced by kind permission.
Andy Poole, Legal Sector Partner, Armstrong Watson
Andy Poole is the Legal Sector Partner at Armstrong Watson, specialising exclusively in advising law firms. Co-author of the Law Society toolkit on Financial Stability in Law Firms, Andy heads the legal sector team at Armstrong Watson, which has 15 offices and over 400 people. The legal sector team advises law firms throughout the UK on strategic, structural and other business improvement issues as well as providing efficient accounting, tax and SRA accounts rules services.
Further information can be found at: www.armstrongwatson.co.uk/legalsector
The Law Society has exclusively endorsed Armstrong Watson for the provision of accountancy services to law firms throughout the whole of the North of England.