Cash Flow Drought: How to Identify and Deal With It
Have you ever heard the term “cash is king”? This refers to the importance of cash flow in the overall fiscal health of a business. For small & solo law firms, cash flow is the lifeblood of running the firm. Positive cash flow allows you to:
- have psychological peace of mind;
- focus on practicing law and operating efficiently;
- obtain discounts from vendors and gain purchasing power;
- be in a position of strength when settling outstanding invoices due;
- earn excellent credit ratings from financial institutions to establish lines of credit; and
- create flexibility in making business decisions.
Cash flow management in small & solo law firms can be particularly challenging. You need to account for the time lag between cash going out and cash coming in. This requires financial and management discipline, strong internal policies and procedures for billing and collection policies, planning and attention to detail.
Most lawyers just want to practice law. While in law school, lawyers never thought they would have to be the CEO of their own practice requiring them to undertake accounting and administrative tasks. Hey, you are running a business!
What creates the cash flow drought?
It doesn’t take much in a professional service business to hit a cash flow drought. The following are a few factors that may contribute to cash flow drying up:
- Poor billing practices – significant accumulation of time before a client is invoiced
- Out-of-pocket costs (client advances) are due before being invoiced and collected from the client
- Firm overhead such as rent and insurance are due monthly while payroll may be due every week or every other week
- Poor internal structure and lack of discipline for accumulating time and getting invoices out in a timely fashion
- No structure for collection of outstanding invoices
- No policy or enforcement for retainers and replenishment of retainers
- Repayment of loans or lease commitment payments and
- Acquisition of equipment or other assets.
There are common themes seen when a cash flow drought is experienced: poor firm culture, lack of discipline, poor organizational skills, little structure and no consistency in applying policies.
Strategies you can implement
The solution is to be proactive. There are several strategies that you can implement to prevent a cash flow drought from occurring and will hopefully enable you to accumulate that rainy day fund.
- Firm culture – how do you want your staff, clients and professional network to perceive your firm? Establishing a strong firm culture that emphasizes the importance and value of client service, along with the significance of timely billing and collections will enable your firm to deliver the first-rate service to clients and ensure staff has a clear understanding of firm goals. Top management sets the tone; you need to lead by example.
- Discipline – deadlines must be established and enforced. Sure there are exceptions; however, they should be few and far between.
- Consistency in billing and collections – inconsistent billing practices, long delays on accounts receivable and languishing WIP (work in process, i.e., work that has been completed but not billed) can wreak havoc on a firm’s finances. Billing and collection policies help keep cash flow positive.
- Business plan – a business plan identifies strategic initiatives the firm intends to implement to reach the partners’ goals. A well-conceived business plan offers a road map for the future.
- Budget – prepare a monthly budget to guide you on what revenue you need to bill and what cash flow you need to generate. The budget should project costs and income. The assumption underlying the budget should be carefully developed and understood. If you have a sense on how much cash you need each month to survive, the sense of urgency to bill and collect is far greater. Many attorneys believe that revenue budgets are meaningless because lawyers never know where tomorrow’s business comes from. The reality is that revenues can be budgeted by analyzing your firm’s larger clients and reviewing the type of services produced over the last several years. From this exercise, trends and client needs can be detected, which can be translated into assumptions and revenue estimates. If a firm does nothing more than ask for an estimate of billings, it will be able to establish a data-base for revenue estimates. In the absence of sound revenue budgets, management decisions for the following year, i.e., hiring decisions, may be made with potentially adverse results, either on the up or downside of the firm’s business cycle.
- Policies regarding advance payments – require that clients pay a fee up-front. By doing so, your clients demonstrate their commitment to the matter. For clients where annual work is performed, prior year work must be paid in full before current year work starts.
- Controlling client advances – this can be complicated since these advances can put a drain on the firm’s cash. Here are some things to consider:
- Try to have your client pay directly for as many advance costs as possible.
- Insist on retainers or at least deposits to cover estimated advances.
- Bill client advances immediately.
- Create a predetermined minimum amount you are willing to advance.
- Partner compensation or distribution – never have the firm borrow for partner compensation or partner distribution.
- Time entry practice – a cutoff date should be established to close out the monthly time posting. By establishing a cutoff date, everyone in the organization works together to post time and create timely billing.
- Billing practice – bill regularly and timely. Send bills at the same time each month and be consistent. It is important to establish deadlines for printing the billing worksheets, writing up the invoice, proofing the invoice and mailing the invoice. There is no rule when to bill. It can be done daily, weekly, monthly or by case or matter. Consider advance billing and retainers. Don’t wait until your retainer is exhausted before securing additional funds from the client.
- Review of unbilled time – firms concerned about cash flow should review all unbilled time and make certain that all files have been properly billed.
- Mailing invoices – set a time deadline for mailing the bills. Consider electronic mailing of bills (this saves time and postage). Some clients today require e-billing. Please make sure your billing system meets the e-billing requirements.
- Collection practices – regular contact and follow-up is vitally important. If payment is due within 30 days, don’t wait 90 days or more to call. Collections issues do not age well, and so it is best to handle these matters while they are current.
- Improve collections by:
- Putting someone in charge of the process and collection calls. Know what you will do first, second and third when the check doesn’t arrive on the due date. Establish procedures to automatically follow up with clients for unpaid amounts. Clients typically always pay first those vendors that stay on top of their outstanding invoices. The squeaky wheel always gets the attention.
- Consider extra measures for larger bills or slow-paying customers. Consider calling to confirm receipt of the invoice and to review any questions. Consider calling again several days before the invoice due date to again handle any questions and, more importantly, gain clarity on whether timely collection will be a problem.
- If you have doubts about a client’s ability to pay, take action. Put them on a payment plan, place a lien on their property or help them obtain a loan from a bank
- In addition to accepting checks, accept payment by credit card or electronic payments.
- Send clients an electronic bill that allows them to pay online, or obtain the client’s consent to charge his or her credit card within a specified period of time after the bill is sent if no objection is lodged.
What to do now?
You are now aware of what positive cash flow creates, what the common themes were that created the cash flow drought and what strategies you can implement to prevent the drought from occurring.
Here are some immediate procedures and strategies you can begin using:
- First step is to get organized and create a budget and worksheet for cash flow in and out.
- Depending on the situation, you may want to create a weekly cash flow worksheet.
- Review your account receivable reports to forecast collection dates for large invoices. Start making collection calls now.
- Consider settling old past-due accounts by giving your client a discount.
- Send delinquent clients a letter that their outstanding balance will be sent to a collection agency which could affect their credit rating.
- Partners may have to contribute additional capital or cease taking compensation until cash flow is positive.
- Establish a line of credit with a bank. The line of credit could be used just to help the ebb and flow issues that arise throughout the year. To obtain a line of credit would require you to have a business plan, current year financial statements and projections, two years of tax returns and personal financial statements from the partners guaranteeing the loans. If your practice has contingency litigation consider obtaining “contingency financing.” For financing based on contingency work, expect your lender to want detailed information on specific contingency cases. The bank will likely also want to take a close at look your track record in winning such contingencies.
- There are companies out there where you can obtain advance payments on outstanding invoices.
- Ask clients for larger retainers. Get as much money up-front as possible.
- Renegotiate extended payment plans from vendors.
- Eliminate and/or reduce cash expenditures that are not vital or productive. Try to convert as many fixed costs to viable costs that you can.
Refining your billing and collections procedures is essential to maintaining or improving the financial health of your practice. Implementing some or all of these strategies will have an immediate impact on your business’ cash position.
Best practices to avoid a cash flow drought require:
- Financial and managerial discipline;
- Strong internal policies and procedures for billing and collection;
- Having a business plan and budget to create a road map for success;
- Strong firm culture;
- Ability to meet all deadlines;
- Monitoring cash flow frequently – stay ahead of the curve;
- Establishing lines of credit to help with the drought; and
- Great client service = premium billing = cash collection.
Implementation of a cash flow management strategy will inevitably boost your firm’s long-term success. If you have any questions, please contact a member of Withum’s Professional Services page by filling out the form below.