Effective cash flow management is more important than ever. Pambos Patsalides gives a guide to getting it right.
Managing your firm's working capital – the amount of money needed to bridge the gap between paying out the firm's outgoings and getting paid by your clients – has a major impact on partner contributions and drawings. With banks becoming more demanding regarding bridging cash flow shortfalls, this balancing act has become critical to a firm's overall survival. Entrenched in this balancing act is the management of lock-up and the firm's ability to look into the future to deal with the cash flow peaks and troughs that may be looming.
First, let's go back to the basics of lock-up. Say a firm's debtors and work in progress (WIP) amount to £5m; and its lock-up (calculated by dividing debtors and WIP at selling value by annual income) is 150 days. This means that, on average, if work begins on a job on 1 January, the firm does not get paid for that work until 1 June. If this firm sets an objective of improving lock-up by 30 days (i.e. getting paid on average by 1 May), the effect of achieving this would be to reduce lock-up by £1m – increasing cash in the bank by the same amount. This means the firm is less likely to require additional finance for its day-today activities – either externally or from the partners themselves.
Practical steps to improve lock-up
- Manage your clients' expectations – provide a quote before you start work and agree a billing and payment schedule in writing in advance. This should also help to minimise fee disputes.
- Give early warning on fee changes – if costs are likely to exceed your fee quote, advise your client immediately and agree a new billing and payment schedule.
- Monitor WIP and debtor days – this should certainly be by department and possibly by individual fee earner. Instigate lock-up and billing targets, and compare the relative performance of different practice areas.
- Separate and empower debt collection – ensure support for fee earners to make billing and collection as easy as possible.
- Understand your client's situation – be aware of how the current economic environment is affecting your client and the likelihood of your fee being paid on time, or at all.
- Reward or penalise teams for their lockup performance – this should be part of the annual appraisal of those responsible.
Seeing the future
The firm's future cash flow requirements must never be left to chance. Your firm should forecast its cash flow projections on at least a 12-month rolling basis. This discipline will ensure that pressure spots, such as partners' tax, VAT and rent payment dates, are identified and do not come as a shock. Your projections model should be based on assumptions regarding income timing and quantum and take account of known and uncertain costs. Share your projections with your bank and keep them informed of changes, giving them plenty of warning regarding potential breaches in facility limits or covenants.
During these difficult times, cash flow management needs be a multi-pronged approach. Lock-up certainly needs to be controlled actively. However, the firm's management also need the right tools to look at least 12 months into the future and to predict the pressure points before they happen.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.