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Vendor Strategy for Law Firms - Working Capital Management

4 mins

Bookkeeping, Working Capital

We’re now in the back half 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.

So without further ado, we will ask again: do you have a sense of how long it takes for your firm to complete the following tasks?

  • Receive a vendor bill and process in your payment system
  • Ensure the bill goes through proper approvals before getting paid
  • Make the payment that you owe to the vendor

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? Turn vendor management into a critical piece of your working capital management strategy?

As always, cash is king. And managing an efficient vendor management process goes a long way in maximizing both cash flow and your net working capital. But first, a final set of ratios:

  • Receivables Turnover = (Total Purchases) / (Average Accounts Payable)
  • Days Payables Outstanding or DPO = (Accounts Payable) / (Total Purchases) * Number of Days

Maximizing Cash Flow

The objective of a sound vendor management strategy is maximizing cash flow. And the first piece of this puzzle is quite simple - gaining a full understanding of the following:

  • Who your vendors are
  • How much you are paying your vendors
  • How frequently they are charging you

Once you have a grasp on this, then you can do some analysis. At my firm, I maintain a detailed list of all external vendors and the month-by-month cost to us. I can then use this data to analyze whether there can be any cost efficiencies gained.

In other words, for each of the vendors you pay, ask yourself if it continues to be a relevant expense to you and if you’re truly getting maximum value from the vendor relationship. If not, you might want to get rid of, or at least alter, that expense.

In some cases, you may be locked into longer-term agreements with vendors. A good rule of thumb here for cash flow maximization is to try to match your revenue streams with your vendor relationships.

For example, if you can consistently project revenue 6-12 months out into the future, executing a one-year agreement shouldn’t do much harm, but think carefully about signing up for any two- or three-year agreements. On the other hand, if you can only project revenue 3 months into the future, you might consider month-to-month contracts.

Understanding your vendor makeup is just one piece to the puzzle, but it helps build the foundation for maximizing cash flow if you can identify efficiencies. Another part of the vendor management strategy involves negotiation, or re-negotiation, of terms.

Again using my firm as an example, in mid-2019 my business partners and I did some digging around what we were paying certain software vendors. We discovered that some of our contracts were coming up for renewal, which presented a good opportunity to re-negotiate with the vendor. And that’s exactly what we did. There are a multitude of negotiation levers: length of contract, payment terms, number of users, volume-based usage, and so on.

Figure out what levers you’re most comfortable pulling in order to get the best deal from a vendor. You may not have the ability to sign multi-year deals, but perhaps you’re willing to pay upfront for one year of service, or add another user. This may get you more favorable pricing on a per-unit basis with the vendor.

Once you feel good about your existing vendors, you can turn your attention to the billing and payments process.

Proper Approvals and Controls

As opposed to our last post on collecting from clients, we wouldn’t say that paying all vendors as quickly as possible is an effective cash flow strategy. Rather, what you might want to consider are the following:

  • Negotiation of payment terms (try for net-15 or net-30 instead of “upon receipt”)
  • Ensuring you’re not late on vendor payments, which could result in penalties or at least soured relationships with the vendor
  • Establishing sound internal controls around approval of bills and payments

Regarding sound internal controls, the goal here is to put some boundaries around being able to process a bill and make a payment from your firm’s bank account.

For example, you may set a policy that requires any bills over $100 needing to be approved by one partner, while any bills over $1,000 need approval by more than one partner. Once the bill is approved, there may be another set of controls around the actual disbursement of cash.

you may set a policy that requires any bills over $100 needing to be approved by one partner, while any bills over $1,000 need approval by more than one partner

If you pay vendors electronically via ACH or wire, perhaps you require written approval (e.g. via email) from one or more partners for each week’s payments before the cash is actually disbursed. And if for some reason you need to write a physical check to pay a vendor, you might need thresholds for signature authority (e.g. two partners’ signatures for checks over $1,000). 

In accounting circles, the idea of “segregation of duties” is critical. Best-in-class companies will have enough different parties involved in a critical process such as cash disbursements, such that not one person has too much control around each step. This will allow for sound cash flow management and help prevent mishaps (whether international or not).

What should I be thinking about next?

Ensure you are paying attention to your DPO (see above for ratio). If you have sound vendor management practices, you can keep this ratio around 15-30 days. Anything less may indicate that you’re subject to strict payment terms (too much “due upon receipt”), while anything higher may sour your vendor relationships.

In our last post on working capital management, we’ll finish putting the puzzle pieces together by taking a brief look at corporate credit card usage and having a policy around travel & expense.