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Credit Cards and Other Debt - Working Capital Management

3 mins

Bookkeeping, Working Capital

This is the final post of our five-part series on working capital management. First there was a brief introduction to working capital management. Then, we talked about why cash is king. And most recently, we discussed the implications of having an efficient billing and collections process as well as a proper vendor strategy. The final piece of the working capital puzzle involves credit cards and other types of debt, which can include the following:

  • Short-term bank loans (due within the next twelve months)
  • Lines of credit
  • Accrued expenses (e.g. payroll or bonuses)

With this final post, we will have covered the essence of working capital - current assets and current liabilities. And as a reminder from our first post, here are some key working capital ratios that you should keep in mind as you assess the financial health of your business:

  • Working Capital Ratio = Current Assets / Current Liabilities
  • Quick Ratio = (Cash + Accounts Receivable) / Current Liabilities
  • Cash Ratio = (Cash + Marketable Securities) / Current Liabilities

Company Credit Cards

This is a straightforward concept, but some law firms we’ve seen do have issues with managing their credit card usage. For example, the different attorneys at your firm may each have their own credit card that isn’t tied to an organization-wide account. As a result of this, tracking and reconciling charges on a regular basis could be difficult. And in some instances this process involves having a paper statement that gets marked up by the attorney and passed off to a bookkeeper, who then manually records the charges in their accounting system. The challenge here is the lack of real-time visibility into your expenses.

To ensure you have a real-time handle on your firm’s expenses, a best practice is to have one company credit card account that syncs to your accounting software (e.g. QuickBooks Online). Each attorney may have their own card, but they are all tied to the firm’s account such that all charges are seen in one place. And by having the integration with your accounting software, on a daily or weekly basis your bookkeeping team can classify credit card transactions as they occur, which will allow for better real-time reporting of expenses. 

Bank Loans and Lines of Credit

A critical component of a law firm’s working capital strategy may involve having bank debt in the form of a term loan or a line of credit. These facilities can be especially useful for firms that generate business on a contingency fee basis. For example, firms that need to pay case-related costs up front before realizing settlement income later on might want to fund these costs using a line of credit to control their cash flow. However, there are some considerations to keep in mind when utilizing these facilities. 

First and foremost, bank debt is not free. There will be an interest expense component on either a term loan or a line of credit that needs to be paid to the bank each month. Additionally, banks may differ on the interest rate applied to their loan facilities (i.e. Bank A charges “Prime Rate plus 1%” while Bank B charges “Prime Rate plus 0.5%”). Firms should budget for this cost of borrowing in their cash flow projections.

Firms should also keep an eye on the balance among their total line of credit facility amount, the amount consumed, the amount available, and the case expenses being funded by the facility. A visualization of all these items (i.e. on a reporting dashboard), with trends over time, will help firm leaders ensure that they have wiggle room within their credit facility and aren’t getting too far over their skis. For example, if you have a $5 million facility, with $4 million outstanding and $1 million available, with case expenses of $200,000 per month, the trends may indicate that your credit limit would soon be reached. Keeping a close eye on each of these components should be a part of your overall working capital strategy.


Sample Line of Credit display from an example Firm's financial dashboard 

 

Accrued Expenses

Last but not least, if you are running your firm’s accounting based on GAAP (Generally Accepted Accounting Principles), versus cash basis, you’ll likely have some accrued expenses on your balance sheet. These might include bonuses earned but not yet paid, accrued vacation time, accrued tax, accounting, or other professional service fees, and potentially accrued interest (if not paid within the month incurred). These should all be part of your working capital calculations and ratios, as eventually cash will need to leave the firm to pay for these expenses. Ensure you are paying attention to these liabilities with the same level of detail as your accounts payable, credit card expenses, and line of credit facility.

In Conclusion

Over the past five posts, we’ve covered:

Focusing on only one or two of these areas, but not the others, may lead to some immediate results. However, to facilitate a more effective and fundamental strategy with positive long-term impacts, each of the above five components should be considered holistically as part of your firm’s overall working capital efforts.

If you'd like to talk about your bookkeeping, or if you're interested in exploring our services for financial analysis and law firm dash-boarding, request a consultation with our team and pick a time that works best for you.

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Jonathan A. Medeiros, CPA, MBA