As we approach the festive season it is timely to reconsider one of the most deeply entrenched and unique features of the financial management of law firms – the year-end billing push. The problem is quite simple; namely that it is common practice in law firms for a significant percentage, often anywhere from 15% to 30%, of the year’s billing and collection to take place in the final month of the year.
In fairness, this isn’t an issue that is unique to UK law firms. American firms face the same problem, as described in this article, but its effects can be more detrimental on this side of the Atlantic because of the difference in the accounting systems firms employ. The cash accounting system used in the US at least means that profits are not booked until cash is received, whereas the UK accruals system has the effect that profits can be distributed to partners before the cash is received in full.
However, the endemic nature of the problem does not mean that firms can ignore it as simply a feature of the profession. The scale of the issue varies and those firms that choose to employ mitigation strategies will enjoy real advantages.
The Cash Crunch
Leaving a significant portion of the year’s billing until December means that the final month of the year is largely spent dealing with billing and collection, rather than the business development and delivery that will sow the seeds for a prosperous start to the New Year. This issue exacerbates the cash crunch that can accompany tax and VAT bills early in the New Year, and places more strain on the firm’s borrowing arrangements – which will not be viewed positively by lenders.
The pressure to realise billing targets inevitably also leads to discounting, and leaving the billing and collection to year-end increases the likelihood of fee resistance and under-recovery, with clients potentially facing difficult circumstances and therefore perhaps being less able to pay. This compounds the problem highlighted above, that the profits booked and distributed can exceed the cash received, thus leaving the firm with a hole to fill in the New Year.
There is, however, a positive to be taken from the year-end habit. That lower lockup and far greater productivity in terms of billing and collection can be achieved in December demonstrates that it is possible, and that the barriers to improvement across the rest of the year are not technical or systemic but are cultural and mental. In many ways the latter issues are harder to overcome than the former, but targets, motivation and peer pressure can go a long way to remedying the problem.
The Quarterly Cycle
Another tangible way of dealing with this issue is to implement more frequent – ideally quarterly – billing targets, thus leaving people with fewer bills to issue and chase at each specified point in the cycle.
The advantages of this approach are manifold. Cash flow is smoother and the amplitude of the peaks in borrowing requirement far smaller, which is news that will be extremely positively received not only by lenders, but also by the SRA, which has highlighted the tendency to borrow to meet VAT and tax bills as an issue. Ultimately it means the likelihood of the firm running out of cash, and facing insolvency, is reduced – and that can only be a good thing.
Greater frequency also instils billing and collection as key disciplines and priorities, and encourages fee earners to see these as business-critical, rather than administrative, tasks. Good practice in this area ought to be regarded as a key component of client care, and regularly engaging with clients on this should reduce the fear with which many people regard these client interactions. People certainly ought to regard their clients with less apprehension than they regard the bank manager.
The American cash accounting system and the cultural ‘eat what you kill’ approach, although not without their own drawbacks, have one further advantage – partner reward is tied to their own collection. However, accrual accounting does not preclude this latter approach – and the more that firms can learn to tie reward to receipt of cash, and to operate more frequent billing targets, the better they will perform financially.