October 23, 2012

Cash Flow Analysis: The Reports that Make the Biggest Splash

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January 2008 Issue | Volume 34 Number 1| Page 57


Cash Flow Analysis: The Reports that Make the Biggest Splash

Advice on budget, timekeeping, leakage and dashboard reports that enable you to keep a steady eye on your cash.

We all like spending money, a fact that’s riotously conveyed in a famous Monty Python skit in which they sing a ditty called “The Money Song.” As the lyrics go, “There is nothing quite as wonder-ful as money, there is nothing quite as beautiful as cash… With money you can ma-ake a splash!” Unfortunately, it’s almost always easier to spend money than to earn it.

So how can you make sure that your practice is bringing in sufficient money to cover your current and future spending needs? As we frequently preach in this column, you need to generate and consistently review the appropriate financial information. This time out, let’s review the reports that your firm can produce to gain a better handle on that all-important asset named cash.

Preparatory Work: Needed Budget Elements

Before you can effectively focus in on cash flow issues, you need to know what you are aiming for regarding your financial goals. Accordingly, it starts with the firm’s budget. A law firm budget can contain varying types and quantities of detail, but for purposes of facilitating cash flow analysis, your budget should contain at least the following information:

▪ Income and expenses, by month and by category (with, we suggest, expenses increased by 20 percent, as a fudge factor)

▪ Annual billable hours expectation by lawyer, broken down by month, week and day (and incorporating work-in-process contributions)

▪ Annual collected fee expectations by lawyer (i.e., collected revenues), broken down by month

You can prepare this budget in a spreadsheet program such as Microsoft Excel, or if your firm has a more-robust accounting system, you can input the information directly into that system. A big advantage of having the budget integrated into your system is that your software should be able to automatically track actual numbers against budgeted numbers, saving you time (and money as a result).

Now, with your budget in place, the next step is to have your bookkeeper generate certain managerial and financial reports that will allow you to track how your money is coming in and how it is going out. Most accounting programs can generate seemingly countless reports, but for our purposes here, we want to concentrate on those that will have the greatest impact from a cash flow perspective.

Weekly and Monthly Reports

To allow you to keep a handle on your financial state without overloading you with information, the primary reports for you to look at weekly are the firm’s timekeeper report and the dashboard report (discussed in depth later). The timekeeper report should be prepared each Monday. It will show you billable hours recorded by timekeeper, compared to the budget, for the week prior.

Monthly reports will go into a bit more detail and let you dig deeper into the hows and whys of what is actually happening in your firm. Here are the reports you need:

Balance sheet for the month

Income statement, by month and by year to date (YTD), compared to the budget and to the prior period last year (note: depreciation and other factors may distort your income statement for the purposes of determining accurate cash flow)

Write-up, write-down report (done on an “exception basis,” meaning you report only on those accounts that are written up or down by at least 10 percent)—by client, by file and by lawyer and showing effective hourly rate by lawyer (i.e., actual billings divided by all time recorded for the billed file, not just the time actually billed)

Accounts receivable (A/R) balance for each client, by total outstanding and by aged balances, and reporting fees due separately from disbursements due

Client activity report, including:

  • Fees billed by client for each invoice
  • Effective hourly rate on the fees
  • Fees collected
  • A/R outstanding, aged
  • Accounts written off
  • Trust balances
  • WIP (total added this month)
  • Unbilled disbursements (total added this month)

And here are some particular things to watch. The write-up, write-down report reveals whether any particular client, file or lawyer is responsible for large write-ups or write-offs. These should, clearly, raise red flags for you. What to do in response? We suggest you combine this report with an office policy that no write-off of more than a stated amount (for example, $1,000) can occur without the signed consent of the managing partner. This provides the lawyers with a strong disincentive to reduce fees without proper management oversight.

Also, the client activity report typically draws attention to problem clients before the problems become acute. In other words, it alerts management to the fact that certain clients may be racking up large WIP amounts while simultaneously not paying their rendered accounts. This is a recipe for cash flow trouble in the not-too-distant future, not to mention the difficulty should withdrawal become necessary, so staying on top of it through a monthly report is very important.

Quarterly Reports

Each quarter should be a time of reckoning. Accordingly, your firm should produce all the previously cited reports along with two new reports: a leakage report and a profitability report. Again, these reports should show a comparison to the current year’s budget and to the prior year.

This is what the leakage report will contain: quarterly billable hours expectation x standard hourly rates (equal to each timekeeper’s billing ceiling), compared to actual billings.

The leakage report’s purpose is to determine the difference between what timekeepers could be billing as compared to what they are billing.

The profitability report takes a somewhat different format. Here is what it is designed to do: determine cost of services rendered for one hour of lawyer time; compare CoSR x hours worked on a file to actual collections; determine if your collections are below, equal to or exceed your costs of carrying the file; and determine fee realization rates, by lawyer, with amount realized/amount billed (as a percentage).

The purpose of the profitability report is to try to allocate fixed and variable costs (overhead) to each timekeeper. There are many ways of attempting to allocate costs—salaries, for example, can be simply averaged or they can be allocated using some reasonable method of determination against each timekeeper or department. Regardless of the methods used, however, the profitability report is designed to answer one question: Did each timekeeper bill at least enough to capture the costs of handling a file in the office?

All firms have particular practice areas or lawyers that are not as profitable as others; but at a certain point, the firm needs to make a conscious decision, from a strategic position, about whether to offer legal services to clients on a “loss leader” basis. If the firm does choose to do so, then it needs to rethink how to offer those services in a way that reduces their financial drag on the firm.

Dashboard Report

The dashboard report delves closely into the factors that most directly affect cash flow, both in the short term and in the slightly longer term. Think of this report as the nerve center of your analysis. The dashboard report should be produced on a weekly, monthly and quarterly basis and provide data relating to cash flow, line of credit, WIP and client files. Figure 1 shows a breakdown of the report’s four components: cash flow analysis, line of credit analysis, WIP analysis and files/clients report.

So what are the key issues you want to look for in the dashboard report? The first component gives you the firm’s cash-in/cash-out status for the period—the cash at the start of the period, plus any additions, less any withdrawals, resulting in the net cash at the end of the period. You then compare the net cash remaining to the expected cash needs for the upcoming period, answering the question: Do we have enough cash on hand to keep us afloat in the short term?

The line of credit component looks at the buffer remaining in the firm’s line of credit. If the net cash remaining plus the remaining buffer in the line is not sufficient to meet the firm’s expected cash flow requirements in the upcoming period, then the firm is desperately in trouble.

The third component reveals whether the firm’s WIP is increasing, decreasing or remaining steady. Increasing WIP is a sign of upcoming cash shortages. Decreasing WIP indicates potential longer-term cash flow problems.

Lastly, the files/clients component answers the question: Are we steadily opening new files? This is a major issue that you want to look at from a much longer baseline. If you are not steadily opening new files, then again, cash flow may be adversely affected in the longer term. So which lawyers are billing and collecting? More importantly, which ones are not? By arming itself with this information, the firm gains the opportunity to address productivity and profitability problems before they become crises.

In sum, the purpose of these reports is to let you maintain a steady eye on the all-important matter of cash in your firm. By doing so, we expect that, as Monty Python has put it: “You can ma-ake a splash!”

Authors’ note: Our thanks to lawyer Jennifer McCallum, PhD, of The McCallum Law Firm in Eric, Colorado, whose e-mails on this subject have led directly to this article.

About the Authors

David J. Bilinsky is a practice management consultant who focuses on enhancing law firm strategy, finance and technology initiatives, as well as Editor-in-Chief of Law Practice magazine. Visit his blog.

Laura A. Calloway is Director of the Alabama State Bar’s Law Office Management Assistance Program.