Billing Basics Revisited: Write-downs and Collections

[Editor's note: While A&FP regularly seeks to explore new and advanced profitability techniques, the wide experience of our authors regularly confirms the vital need to keep an eye on basics. It's been some time since we revisited these particular perennials in the profitability garden. Our Editorial Board member Bill Brennan's review clarifies their importance and provides some fresh insights.]

After working with several hundred law firms during the past two decades I have identified two areas that often offer the best potential to dramatically improve a law firm's net profit. Both of these areas relate to the billing process.

What are they? Neither is a deep, esoteric secret. The first is to reduce write-downs that occur during the billing process, and the second is to implement effective collection practices. In my experience, most firms have identified these problem areas, but few are satisfied with their efforts to deal with them.

Write-downs as Invisible Expenses

Write-downs of billable time can be one of the largest “expenses” of a law firm. It is an “expense” in the sense that it uses up a valuable resource of the firm, ie, unbilled time ' an asset that usually gets converted into accounts receivable and ultimately to cash. Time value that is written down is lost forever, or “expensed.”

Normal expenses such as telephone expense, secretarial salaries, postage, etc., also involve the use of a valuable resource: cash. When these expenses are incurred they require that cash be used to pay for the services. What is most unusual about the write-down “expense” is that it never appears on the income statement. This is because most law firms use the cash method of accounting and this is an accrual basis expense. Thus it is “invisible.”

If write-downs were recorded as an expense on a law firm's income statement, would they really be considered that significant? Absolutely. Consider that for most law firms, regardless of size, an average of about $30,000 is written down for every lawyer in the firm, according to the Altman Weil 2003 Survey of Law Firm Economics. For a 100-lawyer firm, that amounts to about $3,000,000 each year. Clearly this is a significant expense for most firms, and one of the largest for many.

Misconceptions About Collecting Receivables

The other area where law firms can dramatically improve their profitability is in collecting receivables. The only thing that lawyers hate more than recording time and billing clients is collecting their overdue receivables.

This is understandable since it entails communicating with a client to ask for money, often via the telephone. Very few people enjoy calling another person to ask for money, since there is a high probability of getting rejected. Who likes rejection? No one, especially not high achieving partners in law firms.

This process also invites comments from the client about the quality of the work itself, which could be embarrassing to some partners. Some of the common perceptions lawyers have about pursuing collections are not true, as indicated below:

“Collection calls involve confrontation.” If you use a win-win approach, collecting receivables can actually be a positive experience and promote client goodwill. Each client contact is an opportunity to express appreciation for the client's business, to identify any problems with the legal services rendered, and to actively listen to the client's concerns. Making the effort improves overall communications with the client.

“You will get paid at the same time, whether you do anything or not. Why bother with collections?” You train your clients over time as to how you want to be paid. If you historically pursue collections and demonstrate that you expect to be paid in 30 days, you will be paid more promptly than if you just wait.

“Collecting accounts receivable is an event that takes place infrequently.” To the contrary, collecting A/R is a process that begins with client acceptance and continues with every subsequent contact. If you don't from the first clearly spell out what you are to be paid and what services are covered, you will have trouble collecting your billings later.

“We might injure our relationship with the client and lose their business.” If you pursue collections in a professional manner, you can actually improve your relationship with the client. Every contact should be professional, factual and courteous. If a client acts offended when you follow up professionally on an overdue receivable, it may suggest that the client never intended to pay you from the outset.

“It's not worth pursuing an old receivable.” For even relatively small amounts, there is tremendous value in each overdue receivable. Assume that your firm's average profit margin is about 40%; ie, for every $1000 of revenue collected only $400 is profit. It follows that collecting an account receivable of, say, $2000 is fully as profitable as obtaining new work totaling $5000.

Restructuring A/R Collections

Fortunately, the collection process can be structured to be a positive experience. The following five changes are key to a successful transformation:

1. Capture billable time as promptly as possible. Have lawyers submit time records on a daily basis if possible, but at least on a weekly basis. This will minimize the amount of billable time that slips through the cracks.

2. Bill as promptly as possible. The value of services rendered diminishes in the mind of the client over time. Your ability to resolve a critical problem of a client today has great value. If you bill promptly for the work performed it will generally be paid promptly. Next year at this time the client may not even remember the problem and will hesitate to pay any invoice you submit for it.

3. Assign responsibility for collecting receivables to one person. Make sure the individual making your collection calls understands the billing process, is familiar with how Paid and Unpaid receivables are filed, and has ready access to copies of uncollected client invoices.

4. Use a computer system to track your calls if possible. A computer software program that has a calendar reminder capability will be helpful in keeping track of your conversations with different people and will greatly increase your effectiveness in collecting overdue receivables.

5. Build upon personal relationships already established. Avoid sending out form letters from your computer system to their computerized Accounts Payable Department. Make the communication with the other party more personalized by making a hand written notation on the form letter.

In conclusion, it's worth noting that attending to both of these areas will be especially beneficial. By discouraging your lawyers from offering unnecessary discounts, you will have substantially more A/R to collect, and using a proper collection process will generate increased profits.

[Editor's note: While A&FP regularly seeks to explore new and advanced profitability techniques, the wide experience of our authors regularly confirms the vital need to keep an eye on basics. It's been some time since we revisited these particular perennials in the profitability garden. Our Editorial Board member Bill Brennan's review clarifies their importance and provides some fresh insights.]

After working with several hundred law firms during the past two decades I have identified two areas that often offer the best potential to dramatically improve a law firm's net profit. Both of these areas relate to the billing process.

What are they? Neither is a deep, esoteric secret. The first is to reduce write-downs that occur during the billing process, and the second is to implement effective collection practices. In my experience, most firms have identified these problem areas, but few are satisfied with their efforts to deal with them.

Write-downs as Invisible Expenses

Write-downs of billable time can be one of the largest “expenses” of a law firm. It is an “expense” in the sense that it uses up a valuable resource of the firm, ie, unbilled time ' an asset that usually gets converted into accounts receivable and ultimately to cash. Time value that is written down is lost forever, or “expensed.”

Normal expenses such as telephone expense, secretarial salaries, postage, etc., also involve the use of a valuable resource: cash. When these expenses are incurred they require that cash be used to pay for the services. What is most unusual about the write-down “expense” is that it never appears on the income statement. This is because most law firms use the cash method of accounting and this is an accrual basis expense. Thus it is “invisible.”

If write-downs were recorded as an expense on a law firm's income statement, would they really be considered that significant? Absolutely. Consider that for most law firms, regardless of size, an average of about $30,000 is written down for every lawyer in the firm, according to the Altman Weil 2003 Survey of Law Firm Economics. For a 100-lawyer firm, that amounts to about $3,000,000 each year. Clearly this is a significant expense for most firms, and one of the largest for many.

Misconceptions About Collecting Receivables

The other area where law firms can dramatically improve their profitability is in collecting receivables. The only thing that lawyers hate more than recording time and billing clients is collecting their overdue receivables.

This is understandable since it entails communicating with a client to ask for money, often via the telephone. Very few people enjoy calling another person to ask for money, since there is a high probability of getting rejected. Who likes rejection? No one, especially not high achieving partners in law firms.

This process also invites comments from the client about the quality of the work itself, which could be embarrassing to some partners. Some of the common perceptions lawyers have about pursuing collections are not true, as indicated below:

“Collection calls involve confrontation.” If you use a win-win approach, collecting receivables can actually be a positive experience and promote client goodwill. Each client contact is an opportunity to express appreciation for the client's business, to identify any problems with the legal services rendered, and to actively listen to the client's concerns. Making the effort improves overall communications with the client.

“You will get paid at the same time, whether you do anything or not. Why bother with collections?” You train your clients over time as to how you want to be paid. If you historically pursue collections and demonstrate that you expect to be paid in 30 days, you will be paid more promptly than if you just wait.

“Collecting accounts receivable is an event that takes place infrequently.” To the contrary, collecting A/R is a process that begins with client acceptance and continues with every subsequent contact. If you don't from the first clearly spell out what you are to be paid and what services are covered, you will have trouble collecting your billings later.

“We might injure our relationship with the client and lose their business.” If you pursue collections in a professional manner, you can actually improve your relationship with the client. Every contact should be professional, factual and courteous. If a client acts offended when you follow up professionally on an overdue receivable, it may suggest that the client never intended to pay you from the outset.

“It's not worth pursuing an old receivable.” For even relatively small amounts, there is tremendous value in each overdue receivable. Assume that your firm's average profit margin is about 40%; ie, for every $1000 of revenue collected only $400 is profit. It follows that collecting an account receivable of, say, $2000 is fully as profitable as obtaining new work totaling $5000.

Restructuring A/R Collections

Fortunately, the collection process can be structured to be a positive experience. The following five changes are key to a successful transformation:

1. Capture billable time as promptly as possible. Have lawyers submit time records on a daily basis if possible, but at least on a weekly basis. This will minimize the amount of billable time that slips through the cracks.

2. Bill as promptly as possible. The value of services rendered diminishes in the mind of the client over time. Your ability to resolve a critical problem of a client today has great value. If you bill promptly for the work performed it will generally be paid promptly. Next year at this time the client may not even remember the problem and will hesitate to pay any invoice you submit for it.

3. Assign responsibility for collecting receivables to one person. Make sure the individual making your collection calls understands the billing process, is familiar with how Paid and Unpaid receivables are filed, and has ready access to copies of uncollected client invoices.

4. Use a computer system to track your calls if possible. A computer software program that has a calendar reminder capability will be helpful in keeping track of your conversations with different people and will greatly increase your effectiveness in collecting overdue receivables.

5. Build upon personal relationships already established. Avoid sending out form letters from your computer system to their computerized Accounts Payable Department. Make the communication with the other party more personalized by making a hand written notation on the form letter.

In conclusion, it's worth noting that attending to both of these areas will be especially beneficial. By discouraging your lawyers from offering unnecessary discounts, you will have substantially more A/R to collect, and using a proper collection process will generate increased profits.