So You Think You Are Profitable: 10 Ways to Assess Your Law Firm’s Cash Flow

How do you assess how you are really doing? You need to look at much more than just billable hours. The key is cash flow management: You must understand what monies are coming into your practice, and where money is flowing out. Most modern law office accounting systems can give you reports that will give you a much better understanding of the cash flow of your practice. On a monthly basis, you should review the following ten reports from your accounting system:

#1 – Overall and projected monthly billings: What are your overall monthly billings, measured against your projected billings? This tells you if your gross income is meeting projections. Related to this figure is the percentage of collected monthly billings that should be a lawyer’s income. Accoring to Cotterman, this amount should be 55 to 60 per cent(1).

#2 – Projected billings versus cash flow: Review collected billings measured against your budgeted cash flow needs for the month. This tells you if you are in a projected positive or negative cash balance for the month. Studies have indicated that you will have approximately a 105 day ‘lag’ between the date you incur an expense and the day you collect that expense from your client(2). Accordingly, it is important to keep a handle on your potential cash deficit.

#3 – Actual versus budgeted costs: What are your actual costs as compared to your budget? This tells you if you are managing to run your office within the financial constraints that you anticipated. If your costs are high as compared to your budgeted amounts, you will be required to cut other costs to compensate, or increase your collected billings. To be on the safe side, look at cutting your costs first before trying to increase your income, as cost cuts take effect immediately, but income is subject to the collection ‘lag’.

#4 – What is your WIP? Is your work in progress increasing or decreasing? If it is increasing, is it due to time being put into contingency files that have the potential of paying off at some point in the future? Or is it building, as you have not been billing as regularly as you should? On files that can be billed monthly, you are doing yourself a disservice (and potentially digging yourself into a financial hole) if you fail to bill for the work done. WIP over 180 days/Total WIP = 20 to 40 per cent(3).

#5 – What are your unbilled disbursements? They represent credit that you have extended to your clients, and therefore capital that is unavailable for you to operate your practice. If at all possible, bill these out to recapture the necessary operating cash for your office. Disbursements can be one of the biggest components of total firm debt. Total debt/net fixed assets = 50 to 80 per cent(4).

#6 – What are your receivables? Are they increasing or decreasing? What percentage are they of your annual billings? Fifteen per cent is high – five per cent is within the range of acceptability. Uncollectable accounts represent holes in the bottom of the financial boat – that will sink the ship if not plugged. If you do have an unpaid account – do something about it – quickly. Make early attempts at collection and determine whether or not further time and energy are warranted. Recall that attempting to collect an unpaid account against an unhappy client oftentimes leads to professional conduct complaints and malpractice claims – both of which can be emotionally and financially draining as well as PR nightmares. By acting quickly and decisively and staying within your written client credit policy you can minimize your exposure to bad debts.

#7 – What is your realization rate? The realization rate is the percentage of actual income paid to the firm from the billable hours of each timekeeper. For example, Partner X bills 200 hours per month at $200 per hour for a total amount billed of $40,000. Of that amount, 10 hours are written down (taken off the books) for various reasons, and clients pay a total of $30,000. Partner X’s realization rate is 75%. Partner Z bills 150 hours at $200 per month, but she has no “write downs”, and her clients pay 95% of that for a total of $28,500. Although Partner X bills more hours, because of the low realization rate, Partner Z with far fewer hours billed is generating almost as much income for the firm. Your computer-based time and billing program should be able to create this report for you. Examine the results and use it to help guide any discussion of compensation for partners and associates. A low realization rate indicates that a lawyer is using resources of the firm inefficiently – which is usually a sign of poor client or file selection. Realization rates should be no lower than approximately 90 to 95 per cent(5).

#8 – What are your unbilled fees and disbursements by lawyer, client and area of law? Although some may not like it, firms should look at unbilled fees and disbursements aggregated separately by lawyer, client and area of law. Look for trouble-spots in these categories, and take steps to correct them as soon as possible.

#9 – What are your daily lawyer time summaries? Daily time summaries by lawyer are also important. To make this analysis accurate, all lawyers should be accounting for all their time – billable, firm administration or management, education, pro bono, vacation etc. Look for aberrations or time summaries that don’t make sense or indicate poor time management or failure to meet minimum billable time requirements. A quick way to determine how many hours you should be billing is as follows: Take your desired annual income, say $150,000. Collected billings should be approximately twice this figure – $300,000. Factor in bad debt at 10 per cent. That indicates that you should be billing approximately $330,000 per year. There are approximately 231 working days/year (365 minus: 21 days vacation, 104 weekend days, 9 statutory holidays). This indicates that you must bill approximately $1,400/day ($330,000/231). If you bill at $250/hour, this indicates that
you must log 5.6 billable hours/day – every day.

#10 – What are your client trust account balances? Review the trust account balances for every client. Are there funds in trust that can be applied against unbilled time or disbursements? Are there clients/files that are approaching the exhaustion of their retainers or funds in trust? Do you need to write to these clients and warn them that they need to bring in further funds?

These are just a sample of the financial reports that can be generated by most computerized accounting systems. It is important to understand the role that each one can play in the running of your practice and how they can indicate small problem areas before they get to be big problems.

The above content is an excerpt from practicePRO’s Managing the Finances of Your Practice booklet. It is one of eight “Managing” booklets available at www.practicepro.ca/managingbooklets to help you run a better law practice.

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(1-5) Cotterman, James D. Capitalization, Debt and Taxes, Report to Legal Management, June 2000.