Keep cash flow under control and protect your working capital
When you're running a successful legal practice, managing your firm's working capital cycle is critical. Keeping that cycle as short as possible means keeping a close eye on cash funds available, creditors and debtors.
However, given strong client relationships are an equally essential part of doing business, the desire to keep clients happy may mean overdue invoices aren't chased promptly. And that could be costing you more than you think.
"An upswing in debtor days can have a significant impact on your firm," says Ian Marshall, National Head of Legal Segment at Macquarie Business Banking. "It means there's less cash available to your firm at short notice. To cover the gap in working capital, you may need to increase your borrowing levels, hold back paying creditors or require the firm's partners to contribute more working capital."
Ultimately this will reduce the availability of cash to pay regular partner draws.
You're essentially acting like a bank to your clients, putting your firm under unnecessary cash flow pressure and leaving less working capital to fund growth activities or take on new hires.
Debtor days are on the rise
We've seen an increase in debtor days consistently across the industry, with 39% of firms seeing an increase of 20 or more days, according to our 2013 Legal Best Practice Benchmarking Report.
Some reasons include a lack of follow-up procedures or formal collection processes, and limited payment options. We've also seen issues where client relationships dictate payment terms.
Understand the implications
Our modelling highlights the potential savings for a practice simply by decreasing the number of debtor days.
For example, let's say a firm earning $1 million revenue per year sees an increase in debtor days from 60 to 90 days. To fund working capital within this firm, an additional $200,000 is needed each year, and this would need to be funded via overdraft, retained earnings or partner contributions.
"Increases in debtor days also impacts the availability of funds to pay your monthly partner draws, so it's in a practice's interests to put policies in place to support prompt payments," says Marshall.
Refine your approach
So, how can you reduce debtor days in your firm? Having banked law firms across Australia for over 25 years, we've seen firms make a significant impact on their working capital cycle by adopting some simple strategies.
First, technology can help simplify the process.
"I know of some firms that automate reminders through their customer relationship management (CRM) systems, either sent straight to clients or to the relevant partners to follow-up their clients," says Marshall.
"Other firms may decide to impose penalties on clients for late payments, adding interest to overdue invoices. Or they may delay the partner's draw payments until certain invoices are settled – giving them a real incentive to get on the phone and follow-up larger outstanding amounts."
Making it easier for clients to pay is another great way to encourage prompt payments.
"Make it as easy as you can for them to pay, so there's no excuse," says Marshall. "For example, we've helped clients with this by integrating our DEFT payment solution. This means their clients can use BPAY®, credit card, direct debit or even pay via Australia Post. Additionally, DEFT automates processing and reconciliation, and also integrates with practice management software like FilePro."
Some firms opt to use a fee-funding partner to settle invoices on behalf of selected clients immediately, allowing the client to pay the balance over ten or 12 installments while the firm gets payment in full upfront. "It's not something you'd want to do for every client, but it can provide peace of mind and ease cash flow pressure for a firm."
The bigger picture
"Debtor days are just one of the elements that can impact the amount of working capital in your firm," Marshall explains. "The time it takes to generate an invoice once work is complete and your accounts payable processes both have an affect on your cash flow."
How does your firm compare when it comes to debtor days? Our next benchmarking survey launches in August and we encourage you to share insights from your firm.