Cash Flow Management Tips for Law Firms
When it comes to running a modern law firm, cash flow is king. However, the importance of maintaining a steady cash flow is sometimes lost amid discussions about augmenting the top line and slashing expenses to boost the bottom line.
Proper cash flow management is important for law firms because it can help to shield them from financial troubles during slow times or periods of economic decline, or support growth through internal cash flow (versus borrowed funds). While this may sound fairly straightforward, properly budgeting and forecasting a firm’s cash flow can be a lot more complicated in practice. As a result, it’s important to understand the ins and outs of cash flow in order to successfully run your firm day-to-day and to chart a course for long-term growth.
To put you on the path to better cash flow management, we’ve rounded up five essential cash management tips for law firms.
1. Evaluate Your Current Cash Flow and Create a Plan
You can’t make improvements to your cash flow management unless you know what your current situation is. The best strategy is for firms to identify recovery cycles and expenses throughout the year and then create a plan for those short-term and long-term goals. For instance, if your firm is opening up a new office or looking to hire additional staff, you will need funds to materialize those objectives.
Once the short-term and long-term goals have been identified, firms should begin creating a budget that highlights projected income and expenses. To get a better idea of the potential revenues of the firm, you can analyze the firm’s top clients and the nature of the firm’s engagements. Notice any trends that appear, and convert these into tentative revenue estimates.
With a working budget in place, managing partners must have a better idea of both day-to-day costs and large upcoming expenses. Accordingly, the firm will be able to plan in advance for how much cash they will need coming in and how much will be going out at any given point in the year—thus preventing any shortfalls.
2. Implement a Centralized Billing System
Some firms still rely on the more traditional process of lawyer-initiated manual billing. While this may work for very small firms, it’s an unsustainable system that can result in revenue leverage from erroneous billing procedures. This system frequently leads to a delay in releasing bills, which adversely affects the cash inflows of the firm and hampers day-to-day operations. Billing is the first step in the recovery of expenses and a slow billing cycle means that it will take longer for firms to recover their losses.
The solution to cash flow issues caused by manual billing is to keep the billing cycle moving with a centralized billing system. With a centralized billing system, all invoices are generated digitally and then reviewed appropriately before being sent to the client. If a bill is pending beyond a certain deadline, the software will automatically send a reminder to the client, thereby speeding up the payment process. Having a centralized billing system also reduces the scope of human error that can occur with manual billing, ensuring a more accurate billing process overall.
Under the direct costing method, firms are required to allocate variable overheads to WIP. That will mainly include professional costs in case of law firms. However, it’s important to note that there is no clear guidance in the Act or in CRA’s administrative position or even in accounting guidance (both under International Financial Reporting Standard or Accounting Standards for Private Enterprises) for professional services providers, like law firms. Accordingly, the law firms must exercise judgement. While under the absorption costing method, the firm will allocate variable and fixed overheads in the determination of the WIP. Under this method, in addition to variable cost, the firm is required to allocate general overhead expenses.
This results in a faster turnaround, and of course, the faster the billing, the faster the subsequent recovery of expenses. In turn, this helps firms maintain a more steady cash flow.
When it comes to small client expenses such as postage, photocopying, envelopes, etc.—commonly referred to as “soft costs”—many law firms are have gotten used to footing the bill.While these expenses are immaterial on their own, over time, administrative costs can add up. If a firm does not factor these expenses into their overhead costs, the firm will need to drain its own resources for client expenses.
For better cash flow management, firms should be taking these small, but significant, overhead costs into account. The firm’s billing team should be kept up to date on all administrative costs borne by the firm and figure out a way to ensure recovery of those costs. Moreover, the firm’s managing partner should make efforts to minimize such costs. For instance, there may be opportunities to outsource the cost of things such as printing or copying to the client. Whenever possible, it should be regular practice for the client to pay directly for expenses.
4. Address Issues with the Recovery of Client Fees
Neglecting the task of recovering fees quickly can also lead to major cash flow issues.
To ensure a proper balance between collecting outstanding fees from clients and maintaining healthy client relationships, managing partners should take an active role in recovery. Instead of leaving the process entirely to the individual lawyer, managing partners should receive a list of outstanding fees and unbilled transactions. In some cases, it may even make sense to provide individual partners with compensation for properly following-up on bills.
The benefit of having a servicing partner involved in the process is that their personal relationship with the client gives them a better understanding of the right time to convert receivables into recoveries. In addition, managing partner’s involvement can provide guidance to servicing partner that may speed up the recovery process, ultimately increasing cash flow.
5. Proper Accounts Receivable Management
Of course, even with the best recovery and collection plans in place, some clients will inevitably pay late or avoid paying altogether. This is where accountants receivable (A/R) comes in. A/R is essentially the money owed to you by your clients, but has not yet been paid. Managing your firm’s cash flow is intimately linked to the management of your A/R because if A/R turnover time increases, your firm could be at risk of experiencing a negative cash flow—even if it looks like you’ve earned sufficient revenue to cover your expenses and turn a profit. In other words, if customers take longer and longer to pay for your services, your firm will find itself running short on cash to cover day-to-day operations. Over time, poor cash flow can cause your long-term revenue to decline.
As a result, it’s important to have someone—like a CPA—keeping an eye on your firm’s A/R to make sure that the balance does not tip too far in the favor of receivables. This will give you a better idea of whether clients are adhering to your payment plans and whether you have enough cash coming in to cover regular expenses such as payroll for your staff. In other words, working to decrease your A/R turnover time will give you a more reliable picture of your cash flow situation.
At the end of the day, cash flow management and profitability are not one-in-the-same. While profits are often used to pay taxes or pulled back to help grow the firm, cash is needed to tackle day-to-day expenses, such as salaries and administrative expenses. In other words, cash flows are needed in order to actually run the firm, even before revenue is generated.
To ensure that your firm is on the right track when it comes to proper cash flow management, contact the accounting experts at CloudAct.