The Critical Cash Flow Improvement KPI
Poor cash flow will generally arise from one of two issues, or a combination of both. These are:
1) The length of time from matter commencement till payment being too long;
2) Low profitability
Practice owners will often talk about cash flow being poor, whereas the problem is really that the firm is not making the profits that it should.
If that is the case, while speeding up payment will clearly help, the issues affecting the firm’s underlying lack of profitability need to be addressed before cash flow is going to be satisfactory.
To put it simply, if the firm is making a profit of $150,000 per partner and you need $300,000 per partner, that is a profit problem, rather than a cash flow problem.
If however your firm is making a profit on paper of $300,000 per partner but you only seem to be able to draw that infrequently, or you can’t draw all of the profit you need to fund your lifestyle, then you are likely to have a cash flow problem, rather than a profit problem.
(I have included a link at the bottom of the page, to an article that can help you to quickly address a profit problem).
If your firm is in the later situation sometimes, or all of the time, the first thing to do is to have a form a measurement that quickly highlights the problem, so that it can be addressed.
To explain, think about how a matter progresses through your firm.
Once a matter is commenced, your firm starts to progressively allocate working capital to that matter.
Initially that capital may be in the form of work in progress ( WIP) and once it is billed, that working capital will be in the form of debtors ( accounts receivable).
The combined total of the WIP balance and the debtor balance represents your firm’s working capital investment in that matter at any point in time.
I will refer to that total investment as the amount of money “Locked Up “in working capital or “Lockup” for short.
The sum total of WIP and debtors for all of your firm’s matters at any point in time will represent your firm’s working capital commitment or “Lockup”.
The lower that figure the better, assuming it is coming from managing cash flow well and not because the firm simply doesn’t have enough work!!
The trouble with an absolute figure like “Lockup”, is that it is hard to compare results.
Let me explain with an example.
Partner A has lockup of $100,000
Partner B has lockup of $200,000
Who is managing their lockup the best?
While on face value, partner A is doing a better job, the answer of course, is that you can’t really tell because you don’t have enough information.
What additional information do you need?
You really need to know what fees that each lawyer is planning to generate for the year.
If you now know that partner A is planning to generate annual fees of $300,000 and partner B is planning to generate $800,000 in fees, the situation is much clearer:
Partner A Lockup $100K/$300K = 33%
Partner B Lockup $200K/$800K = 25%
In this case Partner B has a lower proportion of total fees “locked up” in working capital and so is doing a better job, in the absence of any further information such as type of work etc.
I find a better way of expressing this, is as “Days of Lockup”.
In the above case:
Partner A Days of Lockup = $100K/$300K X 365 days = 122 days
Partner B Days of Lockup = $200K/$800K X 365 days = 91 days
This KPI is expressing the length of time it takes for the average matter to progress from commencement to payment. The shorter the time, the lower the working capital requirement and of course the better the firm’s cash flow.
By expressing the firm’s investment in working capital as days of lockup it is easier to compare and it becomes much clearer what has to happen to improve cash flow.
By using the KPI Days of Lockup, you can readily compare different fee earners, different years or even different firms. With this KPI you can readily compare working capital management without needing to know confidential things like total fees, which makes comparisons between firms easier.
In my experience the KPI “Days of Lockup” is a better KPI to help fee earners to manage working capital. For example if the firm’s target is 120 days of lockup, it is easy to see where you stand in comparison and your energy can then be applied to strategies to reduce working capital.
If you are looking to improve cash flow, using the KPI Days of Lockup is a great way to quickly focus your energy to the working capital problem areas in your firm and address them.
Is your cash flow problem really a profit problem?
If so, read this article for the two quickest and easiest ways to improve profit.
Ready to deal with the cash flow problem?
If you are ready to deal with the problem our recently developed Cash Flow Improvement Program can save you time in developing your solution
The link is Cash Flow Improvement for Smaller Law Firms OR navigate to the “Shop” on the Ritchie Business SOlutions website.