Law firms are not banks. Banks are able to borrow money at almost no cost, and of course make money by charging interest and fees. Firms today are facing increased constraints in their management of cash. Unlike banks, they make very little or no money on their “loaning” of money to clients in the form of client chargeable expenses. Firms need improved processes and tools to better manage cash flow.
The 2008-2010 economic downturn has resulted in a drop in billings, stretched out client payments and tougher access to lines of credit. One often overlooked source of cash is accounts payable, and the management of the overall spending process.
Let’s take a look at the three-part Cash Management Cycle of a law firm. This cycle includes two assets and a liability; work in process (inventory), accounts receivable/collections and accounts payable. Accounts payables and the entire spend management process is often under managed.
There are three ways firms can manage the overall cash spending process:
- Get more cash in advance, or keep from using firm cash for client expenses.
- Better manage the spending approval process with accountability and approvals.
- Better understand and manage actual cash payments.
Here are some tips for getting more cash in advance or using less firm cash:
a) For large client chargeable expenses such as outside experts or expert witness fees, financial audits, and so forth, arrange with the client for a direct payment “pass through”. In this case the vendor bills the firm for the expense, the firm approves the invoice and passes it directly to the client for payment. This way the firm never records the expense on its balance sheet and is not liable for payment. The firm should have the AP system track this pass through so as to respond to any vendor inquiries. Make sure the vendor understands the “pass through” process.
b) Many clients are resistant to providing firms with big retainers, especially when they see the retainers being used for fees. Negotiate with clients to provide retainers designated for hard-cost expenses only. Your bill should always reflect expense retainer activity along with an image copy of each vendor invoice appearing on the bill. Your accounting system should handle this.
c) Negotiate where possible with vendors providing client chargeable services that the firm will pay vendor invoices when the firm’s clients pay. Assure the vendor that all funds paid by the client will first be applied to “hard-costs” before firm fees are paid. Your system can automate this entire process without special handling.
Here are some tips for managing the Spending Process:
a) Implement a process requiring vendor invoices be approved by the person requesting the products or services along with at least one level of management. For example, a secretary and her billing attorney would approve an invoice for special outside copy expenses. It’s amazing how many invoices do not accurately represent the services either ordered or provided. An AP clerk would have no way of knowing this level of detail.
b) Make people with spending budgets responsible for approving invoices. If a marketing manager has a budget and incentive for operating within budget allow the manager to have approval for all invoices being charged against this budget. Many firm managers with spending budgets never see or approve invoices prior to payment. They only see reports showing actual to budget performance periodically throughout the year. They never are engaged in approvals.
c) Today’s accounts payable systems can easily align spending with management goals. Workflow technology allows staff and attorneys to approve all expenses before they are entered into accounts payable. Imaging of vendor invoices reduces costs and makes this process much easier.
Here are some tips to better understand and manage actual cash payments:
a) Understand your Average Payables Period (APP). APP is calculated by dividing the firm’s annual payables by 365 days, this provides the Average Daily Payables (ADP). Then divide the current accounts payable balance by this average to get the Average Payables Period. Can the firm increase the APP from say 30 to 40 days, generating an extra 10 days’ worth of ADP? You’re system should classify vendors who will allow their payables to be stretched, take advantage of their generosity.
b) Negotiate for vendor discounts for faster payment cycles. For example ask the vendor for a 2% discount for payment in 10 days. This works well if the firm has reasonably good cash flow. Firms use to make money on bank “float”, interest made on short-term cash reserves. This is no longer the case and cash discounts for early payment might look attractive. Ask your vendor if there is an additional discount for ACH payment since it is quick and eliminates paper check processing.
Law firms are not banks, “Cash is King” and firms can better manage their cash flow by better managing the accounts payable process.
