The following is an adapted excerpt from Results-Oriented Financial Management.
This analysis shows the changes that will occur in the accounts receivable reconciliation portion of the budget. Note that the collections were budgeted at $4,799,094. As a result of the reduction in billings, assuming the 65-day time-to-collect period can be maintained, receipts will be reduced by $189,560, making the new projection $4,609,534. On a per-shareholder basis, this amounts to a shortfall of $23,695, as shown in Figure L.
This budget review can be done at any time throughout the year to provide the manager with the tools he needs to take action to improve the situation. Now that Able, Baker has a better idea of the problem, it must work toward lowering the anticipated reduction in billings and collections. This must be done on a firm-wide basis, all the way down to the individual billing-lawyer level, to find out who is controlling the dollars and what must be done to improve the results.
A long-held theory in law firms is that the most important person is the one who bills the most and collects the most. This is not necessarily true. While managing many clients and many dollars is certainly impressive, the most important person is the one who bills and collects the highest portion of the money available to him. A lawyer who bills and collects $50,000 of an available amount of $100,000 is performing poorly compared to a lawyer who has $20,000 available, and bills and collects $20,000. Since most firms operate on a billing lawyer basis, it’s possible to pinpoint the billing and collection problem by reviewing how lawyers are doing against the amounts available at any point in time. Figure M illustrates a system that assists in this effort.
The theory behind this reporting system is to first calculate the percentage of collections required as compared to the total amounts available for collection. These amounts are represented in Figure M in the columns titled Beginning Work-in-Process, Beginning Accounts Receivable, and Amounts Added for the Period. This is first done at the firm level and then at the billing lawyer level.
For example, in Figure M, note that through June 30 Able, Baker had $4,472,884 available to collect. This resulted from a beginning work-in-process balance of $880,560, beginning accounts receivable of $792,560, and amounts added of $2,799,764. Since its budgeted collections were $2,265,492, the required percentage of collections in order for the firm to reach its budget at June 30 is 50.6 percent, versus a budgeted percentage of 48.2 percent. Thus, the firm needs to improve its turnover rate of time to cash receipts if it expects to achieve the same level of receipts with a reduced value of billable time. After looking at the figures for the firm, Able, Baker can then examine the numbers for each billing lawyer to determine his or her individual performance.
Figure M includes the individual information for lawyer Mary Smith. Note that her amount available to collect, using the same process as done for the firm, is $508,956. By applying the percentage for the firm of 50.6 percent, we see that Mary’s receipts budget is $257,784. Her actual is $206,884, leaving her a deficit of $50,900.
The ultimate goal is for everyone in the firm to meet their targets so that the firm reaches its target. Obviously, not everyone is able to do so. Some lawyers are over and some are under. The objective is for as many lawyers as possible to meet or exceed their budgeted receipts. Those lawyers who accomplish this goal make the “honor roll,” which is announced monthly to everyone in the firm. The number of times an individual lawyer makes the
honor roll is one of the criteria used in determining compensation.
Firms have been very inventive in establishing bonus programs for partners who exceed their budgets for billable hours, origination, working receipts, and so on. However, these figures do not matter if the time value is not converted into a high percentage of the available cash receipts. A partner must bill and collect quickly, with a minimum of write-downs and write-offs. This is the test each partner must pass if a firm is to meet its overall budget and meet or exceed its projected cash realization percentage.
Your Guide to Strong Financial Management
This post was adapted from the Law Practice Division’s publication, Results-Oriented Financial Management: A Step-by-Step Guide to Law Firm Profitability, Third Edition. In this book, author John G. Iezzi, CPA explains how you can examine every facet of your financial affairs from cash flow and budget creation to billing and compensation.