ACCOUNTS RECEIVABLE COLLECTION
By Robert James Henderson ©
Dramatic improvements can be made in firm profitability by increasing the pace of cash flow. This is accomplished by decreasing “turnover time”, which is the amount of time, expressed in days or months, which is required to convert an hour of billable time at standard rates to cash.
The first step is to determine total turnover time, or how long it takes the firm to convert time into cash. Two separate calculations are required: a. The turnover of unbilled time, and, b. The turnover of accounts receivable.
a. Unbilled time turnover. This is determined by dividing the amount of unbilled time by the average of each month’s billings for the year to date. Thus, if the firm carries a balance of unbilled time of one million dollars, and average monthly billings are $250,000, then it takes an average of four months to convert time worked into billings.
b. Accounts receivable turnover. This is determined, first, by taking fee receipts for the year and dividing them by the number of days elapsed in the year (assume fee receipts for four months of $1,000,000 and divide by 120 days-that would mean the firm averages about $8,333.33 per day in fees received), and second, by dividing the average daily fee receipts into the amount of accounts receivable being carried at a given time. Assuming the carrying value of the accounts receivable is $1,000,000, dividing that amount by 8,333.33 establishes that it takes 120 days on average to collect accounts receivable.
If it takes four months to convert time worked to billings, and then it takes another 120 days to collect the bills, the total time that it takes to turn an hour of time into cash is approximately seven months, on average. Obviously, anything that can be done in billing and/or accounts receivable collection to cut down on that amount of time will have a dramatic impact on cash flow, and thus upon overall profitability.
a. Review current billing practices and rates, to be sure files are billed regularly according to applicable billing cycles, try to establish monthly billing cycles wherever possible, and review rates to be sure are they appropriate.
b. Assuming that bills are generated and submitted on schedule, the emphasis then must shift to organizing an effective follow-up program. This involves monitoring the payment pattern, and diplomatically finding a way to make clients pay their bills in a timely fashion. Lawyers by nature tend to resist even the most modest efforts to collect overdue accounts.
When clients are allowed to take their sweet time to pay their bills, it sends a message that it is all right to do so. Given that message, clients will always take advantage of you. As a matter of fact, it has been demonstrated that if a firm allows a client to go beyond 60 days past due, there is a 62% probability that it will occur again. If you allow it a second time, there is a 95% probability that all future accounts will be paid beyond 60 days.
Once a bill for legal services is generated, the clock starts to tick, and the receivable begins to depreciate. This is due to a combination of the effects of inflation, the cost of financing accounts receivable, the cost of the collection effort and the declining probability of collection. After 30 days, for instance, the value of a bill in the amount of $100 is $97.00. The value continues to decline to $90.00 after 60 days, $80.00 after 90 days, $73.00 after 120 days, etc.
Most businesses insist that their own bills be paid when due, and they likewise expect to pay everyone else to whom they owe money on time. Is there any good reason why that should not also apply to their lawyers?
In view of lawyers’ traditional reluctance to “dun” clients for payment, a key element in an effective accounts receivable collection system is to remove the responsibility to collect bills from the billing attorney after a reasonable amount of time, such as 60 days. After that, the administrator should function as a credit manager. He or she should be able to deal effectively with client representatives to secure payment, without jeopardizing the client relationship.