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Here’s yet another fallacy about law firm profitability: You perform the work, send an invoice to clients — and you get paid. It sure sounds logical, but the surprising reality is that many firms actually lose money on legal work, often unknowingly. It’s not as simple as calculating the fact that a $200-an-hour attorney billed 20 hours on a matter for a total of $4,000 in revenues. Why not? Because law firms in the U.S. operate on a cash accounting basis. In other words, revenue isn’t recognized until the cash comes in. In essence, your firm could have had a great year bringing in new work, along with a record number of billable hours, and still see decreasing partner distributions because of that uncollected cash. Law firms are in business to make money. The most basic formula for calculating profitability is “Revenues minus expenses equals profits.” So, where’s the opportunity? The law firm business model has limited flexibility in terms of costs. The two largest expenses — staff and attorney compensation and facilities fees — cannot easily be changed and are destined to increase over time. However, the revenues part of the equation, from pricing work to billing and collections, includes numerous variables that can improve a firm’s profitability. The most direct and effective, yet often overlooked, approach to enhancing profits is to improve realization — getting clients not only to pay their bills but to pay them faster as well. Failure to manage the collections process early on is like letting money slip through the cracks. The chances of collecting the full amount of an invoice decreases as the receivable ages. After 90 days, that $4,000 invoice will probably not be paid in full, if at all. To compound matters, many firms have lines of credit with their banks that are based on the percentage of the accounts receivable (A/R) under 90 days old. Banks generally view A/R over 90 days as noncollectible and no longer an asset to the firm. As a result, the firm’s access to cash is lessened. Understanding the variables that affect a firm’s ability to collect from its clients can make the difference between a profitable law firm and an unprofitable one, and a thriving partnership or an unstable one. Start at the beginning. Before any billable work is performed on a matter, the estimated costs (for instance, billable rate multiplied by the number of hours to complete the work) should be communicated upfront. While $150 per hour may seem like a reasonable rate, it may actually be far beyond a client’s budget if the matter takes 100 hours to complete, especially if the client imagined it would take 20 hours. “Get started on the right foot so you don’t have write-offs later. Too often, firms focus on billing rates without forethought into the number of hours the matter will take, if the matter is priced correctly, and if it is properly staffed. This leads to end-of-the-month sticker shock for the partner and client and, ultimately, unpaid invoices,” says Mark Grant, CPA and president of a D.C.-area financial consulting firm. “Set expectations upfront by taking the time to properly set billing rates, provide appropriate time estimates, and communicate this information to clients from the beginning. Why incur any billable time if the client cannot afford it to begin with?” Of course, your firm does not want to have to turn away business, but it can be difficult to keep rates competitive and still remain profitable. If the client does not agree to the costs, look for alternative solutions that are both affordable to the client and profitable for the firm. Grant suggests “best fit” staffing as opposed to the usual suspects. Does an attorney in another office have expertise that will allow the work to be done faster, or at a lower billable rate? Can the Cincinnati office handle the particular matter more cost-effectively than the New York City office? Should an attorney with a higher billing rate focus on bringing in new business and delegate the work to an associate who can get the work done while gaining valuable experience? Also, remember to bill swiftly. Your firm cannot collect on invoices that haven’t gone out. Providing invoices in formats specified by clients (for instance, electronic versus paper) along with appropriate backup can speed the time it takes to get paid. “All of our attorneys enter their own time electronically. It’s more efficient and more accurate. It’s sped the billing process to one to two days after the month closes,” says Barbara Hozinsky, controller for Southern California-based Goldstein, Gurvitz, Marlowe & Miller. “By entering their own time, the attorneys can better describe the work, so there are fewer discrepancies and client questions. Plus, they can stay on top of business by seeing the results of what they’ve billed.” MAKE COLLECTIONS A PRIORITY A poorly managed collections process sends the wrong message. By not consistently following up on past due invoices, you’re indirectly “training” your clients that it’s acceptable to pay late. While most firms have great accounting systems for billing, the majority do not use technology to manage and measure collections. Typically, firms print out lengthy A/R reports and then manually review them for invoices past an acceptable due date or dollar amount. Then, the collections staff or billing attorney usually follows up with those deemed most critical. “Managing collections manually was overwhelming. I’d have to run reports, highlight problems, pull invoices, and then follow up. Because of this, we would tend to focus only on the larger dollar amounts, and some smaller invoices would inevitably get lost in the shuffle,” says Hozinsky. Fortunately, the collections software available today can help firms automate the process to improve cash flow and maintain good client relationships. Look for software that integrates with your firm’s time-and-billing system so that information doesn’t have to be rekeyed. Grant recommends selecting software that allows the user to set up wizards so that when invoices get beyond a certain date or dollar amount, you are automatically notified that they are flagged for follow-up. “You can take action sooner, without having to run a report — it’s all there for you. With collections, it’s important to get the cash in as soon as possible. Every day counts.” “By utilizing collections software, it’s all done for me, even down to automatically generated letters that list all of the open invoices, which makes it simple to reprint them. The clients have responded positively; they wanted efficiency. I’m getting fewer phone calls because I’m on top of things, and our realization has greatly improved,” Hozinsky says. Further, a professionalized collections process helps reduce the need to have attorneys follow up on delinquent accounts. This way, awkward client confrontations that can hurt the relationship are avoided, and attorneys can focus on other billable work. Take the time to review and revamp your firm’s collections practices — it’s money in the bag. Jim Hammond is president of RainMaker Software Inc., a provider of financial management, practice management, and business intelligence solutions for midsize to large law firms. He can be reached at [email protected].

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