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Working Capital Management: Efficient Collections

2 mins

Bookkeeping, Working Capital

Do you have a sense of how long it takes for your firm to complete the following tasks?

  • Determine the correct amount to bill a client
  • Create an invoice and send to the client
  • Collect the money you are owed from the client

If you know how long it takes, that’s a great first step. Beyond knowing how long it takes, do you know how you can improve the process? Make it more efficient? Reduce the amount of time it takes for you to turn your work performed into cash? As we know from the last post, cash is king. And managing an efficient collections process goes a long way in maximizing both cash flow and your net working capital. But first, a couple more ratios:

  • Receivables Turnover = (Total Revenue) / (Average Accounts Receivable)
  • Days Sales Outstanding or DSO = (Accounts Receivable) / (Total Revenue) * Number of Days

Billing: Easier to Control

We will turn our attention to the collections process next. But first, let’s talk about billing. My personal experience with many companies is that their invoicing process is… not fast. When I’m on the receiving end of various services as a consumer, I often go weeks or months wondering when I might receive an invoice for any work that I assume requires payment. For law firms, there are certainly valid reasons for not sending invoices frequently (e.g. waiting to bill a client until a particular matter is closed). That being said, efforts should still be made to make the billing and collections process as efficient as possible. 

The easiest thing to control in the cash collection cycle is how quickly you can get your invoices out the door. First, make sure you have a tool for creating and sending invoices efficiently (QuickBooks Online, LawPay, Clio, or Practice Panther would all get the job done). Second, you and your team of attorneys should be logging time on an ongoing basis rather than waiting until after the month ends or later. And finally, someone in your firm should be the point person for accumulating all billable hours, spinning up the invoices in your billing tools, and sending them off to clients.

Once the billing process is squared away, you can turn your attention to the collections process. This is harder to control, but there are some best practices that can help out here.

Collections: More Difficult to Control

Getting clients to pay for services quickly can be an exercise in grit and fortitude. One of the first things to think about that can speed up the process are the payment terms. Are you offering 45- or 60-day payment terms? Even if you are doing 45-day payment terms, are your clients still taking longer than that to pay? Alternatively, starting to mandate 30-day payment terms should enhance your collections process. This may be easier to do with new clients where you can establish this precedent from the outset, rather than existing clients that are accustomed to taking longer to pay.

Next, if you have a point person for the billing process, this person can also send friendly reminders at set increments past the billing date. For example, you could give a gentle nudge a week or two after the invoice was sent, confirming that the client did, in fact, receive your invoice, and another gentle nudge just before the due date to check in on payment status. The folks you’re invoicing are likely quite busy and simply could have forgotten about it, so friendly reminders might help move them along.

Unfortunately, not all clients will pay in a timely manner, regardless of payment terms or friendly reminders. They are also trying to manage their own working capital and are running their business at their own pace, not yours. Additionally, they could have some cash flow issues. In these cases, slightly more direct measures could be necessary. You may need to remind the client of the terms in the agreement they signed, and/or inform them of the repercussions of nonpayment. As a last resort, having a trusted collections agency to help with this process might also make sense for your firm.

What should I be thinking about next?

Ensure you are paying attention to your DSO (see above for ratio). Best-in-class companies with sound billing and collections practices can keep this ratio under 60 days, while an acceptable range is between 60 and 90. Anything more than 90 could be worrisome, and if you’re above 120 days then you may have a serious working capital problem. 

The first piece of the working capital puzzle we tackled was cash management. And in this post we covered accounts receivable, billing, and collections. In the next part of the series, we will explore the accounts payable and vendor management piece of the puzzle.  

Jonathan A. Medeiros, CPA, MBA