A wind of change is blowing through the legal world and the quick to react have filled their sails and are on course for calmer waters. Chambers are becoming more entrepreneurial in order to increase business, whilst protecting profits and mitigating financial risk. A glance at the accounts can give an instant image of a chambers'/law firm's performance and as the sales ledger can account for 40 per cent or more of assets, many sets and firms are turning their focus to cash-flow management in order to counter growing cash-flow risks. To some, cash-flow management simply means debt collection, but to the wise it is a comprehensive and invaluable set of management practices, carefully devised and infinitely adaptable to provide maximum financial stability – especially during periods of economic uncertainty.
What is the Aged Debt?
The primary tool used in cash-flow management is the aged debt report as it details all billed fees that have been issued but have yet to be paid. When addressing overdue accounts, or analyzing cash flow, it is important that the aged debt determines the position in the specific overdue period (age band) from the date of the fees note and calculates this using the specific number of days allowed before payment becomes due for each work type. The result is a single report providing a management summary of all bills raised. A chambers or law firm that operates terms of business for all instructions will have clarity on payment due dates and therefore will find it easier to create an accurate report. Whilst specialist software makes creating the reports quick and easy, it is possible to use a simple spreadsheet package. Once the basic data is input, sorting the data in different ways allows the development of a package of detailed reports that can be produced as required. Regular analysis of the aged debt and making comparisons of snapshots taken at each month end becomes a useful opportunity for action planning and setting goals for financial targets.
What costs arise from aged debt balances and how can I manage them?
Clearly, having unpaid fees ties up revenue that could be used elsewhere and therefore an aged debt with high overdue balances has a cost to your organisation. In effect, the aged debt represents credit granted to debtors for the period that it remains outstanding. Interest on capital is lost for the overdue period. As tax is payable on services billed, rather than services paid for, this incurs further cost. A lack of cash flow may lead to barristers or the partnership resorting to obtaining a loan against the value of the aged debt. Several financial companies and banks offer this facility, but again at a cost to your organisation. Last but not least, there is the hidden cost of the finance department spending more time than necessary chasing unpaid fees. In addition to enabling your organisation to set priorities on fees recovery, manage lock-up, set targets that deliver financial strategy objectives, monitor payment trends and feed data into cash flow forecasts, there are a range of other benefits that working with the aged debt can deliver. Furthermore additional reports useful for maximizing cash flow include debts analyzed by reason code, and disputes analyzed by reason code.
Can I categorise debts to improve debt recovery?
There are many reasons for debts remaining unpaid, such as a client's temporary cash flow problems, quality of service, or fees note not received. If reason codes are set up and applied to each unpaid bill, it is possible to calculate the sum ultimately recoverable and how much debt will need be written off. It will also become apparent if there are any training needs leading to quality issues and identify those who will benefit from assistance with fee collection. Once the reasons for non-payment are known, appropriate resource can be applied to get the cash flowing again. Debt situations are often temporary, so it is preferable to remain on good terms with the "debtors" that can be retained and returned to "client" status.
How can I manage and resolve disputed invoices?
A report identifying all "disputed" invoices recording the reason for the dispute, supported by notes of action taken in each case, enables the finance department to progress matters through to a resolution in the shortest timeframe. Put simply, having removed the reason for nonpayment, cash flows again. Monthly progress reviews ensure that matters never stagnate. These can also double up as skills audits and opportunities to praise individuals for work well done.
How does ongoing client communication improve cash-flow management and therefore reduce aged debt?
Regular review of the reports provides an additional opportunity to communicate with clients. If client contact is made throughout, rather than just when a problem arises, dealing with financial issues will be much less stressful. When handled well, difficult calls concerning disputes, or even fees recovery, can lead to stronger relationships and more business. It is important to see these calls as an information gathering exercise - many such conversations lead to market intelligence being gained and when shared with the relevant personnel, further instructions result.
Conclusion
Cash-flow management, with the aged debt at its heart, should be an integral part of your organisation's management strategy. There are tangible benefits to enhancing the skills of staff working with this tool. Exploiting the information gained will directly enhance the speed of cash flow, help rehabilitate temporary debtors, crystallize perception of client service, identify opportunities for obtaining further instructions and improve client retention. Accordingly there is a clear case that they make a direct contribution to profit.
Julie Cave is the Head of the Finance Recruitment and Consultancy at LPA Legal Recruitment (October 2010)