Cashing up

Having the firmest grip possible on the key processes in a firm’s revenue cycle has become an even greater priority in the cash-strapped course of 2009.

By Steve Gale, audit partner, professional practices, Horwath Clark Whitehill LLP

The reality is that businesses fail not because of a lack of profitability but because of a lack of cash. It is entirely possible to show a trading profit, with charges to clients exceeding the salaries and overheads, but a firm’s outgoings are normally more predictable and regular than its incomings.

Typically, significant cash outflows are these: staff are paid monthly, rent is paid quarterly, and many of the other significant overheads are monthly or at agreed dates. Of course, partners expect their drawings to be paid monthly and most practices will retain amounts to pay partners’ personal tax liabilities, which fall due for payment on 31 January and 31 July each year.

One of the key questions that needs to be answered is: does the pattern of cash inflows meet the pattern of cash outflows? If it doesn’t, practices need to obtain additional finance to meet the gap, normally either from the bank or from the partners themselves. In the present economic climate, however,
with the banks’ credit committees being more demanding before approving facilities, practices should be doing all they can to improve the predictability of the income flows.

The revenue cycle

It is easy to say that this can be achieved by billing more regularly, but although this has a part to play, it is by no means the whole story. The billing process is just part of the revenue cycle, and it is as important to address the other elements of that journey as well: the acceptance of client instructions, agreeing terms of engagement, doing the work, and finally, collecting the cash.

Acceptance of client instructions

It is tempting, especially in difficult times, to accept all instructions that are offered, but this can be misguided. If the ultimate aim is to convert the instruction into cash, taking on a new client without at least checking whether that client will be able to pay bills delivered jeopardises the very aim at the earliest possible opportunity.

Accordingly, practices should ensure they have robust client-acceptance processes. This is to assess not just the credit risk but wider risk-management processes as well.

Where has the introduction come from? Is it from a reputable existing client, whose judgement you trust or have they approached you ‘cold’? Will the firm be happy to be associated with the client? Could taking on that client jeopardise your relationship with other existing clients or your potential to engage other new clients? Does the practice have the necessary expertise to carry out the work being requested, or would it be more appropriate to decline the appointment but suggest another firm who might be better placed to service the client’s needs? That may seem anathema – to seemingly provide income to another firm – but one has to consider the opportunity cost. The time not spent on that piece of work is available for other work that the practice is better placed to handle, and which, ultimately, will be more profitable.

This is not the end of the client-acceptance process, but at this point one should have established whether the instruction should be accepted ‘in principle’.

Agreement of terms

The second part of the acceptance process also offers the first opportunity to lose money, namely by under-quoting for the work to be carried out. Of course, there is competitive pressure, particularly when there is a greater focus on needing to improve income, but getting it wrong at this stage can provide plenty of long-term pain.

As professionals we take pride in our work and need to have the belief that our charges are justified. Our clients will gain value from the advice they receive, and should, therefore, pay the appropriate amount. If we under-quote to secure the work, that knowledge can stay with us throughout the assignment, with that nagging voice that says this client does not value our expertise. This can adversely affect our motivation, and when it comes to prioritising workloads it is normally the clients that make us feel valued who rise to the top of the pile. If motivation is not at its highest, it may mean that the service delivery is, likewise, not of the premium quality. That, in all likelihood, transmits itself to the client, and no doubt then becomes a subject for discussion when raising the bills.

When agreeing terms, there is opportunity to introduce greater certainty into the income flow. On what basis is the work to be carried out? Will it be on a straight time basis, a fixed fee, or will it be a conditional or contingent-fee basis. There is an argument that this aspect of agreeing the terms should play a part in the client- acceptance procedures described earlier. After all, contingent fee arrangements are likely to decrease the predictability of the income stream rather than increase it. Yes, the work can come with premium pricing, but if there is no certainty that a fee will be forthcoming, whether or not to accept the appointment should be considered very carefully. After all, the salaries and overheads are not contingent – they have to be paid no matter what.

When assessing whether to take on a new instruction, a former partner of mine used to warn against having ‘happy ears’. This is the point where one starts to ignore the warning signs that are starting to flash because of this need to secure the additional income the new instruction will bring. This can apply equally to instructions from current and new clients. What has our experience of undertaking this type of work been before? What have our dealings with this client been like in the past? You need to resist the temptation to gloss over these experiences and convince yourselves it will be better this time. It may well be, but there is no guarantee of that, and if our experience has been consistent in the past (and when the economic climate has been fair), is it really realistic to expect things to be different this time? There is danger in taking on new work just because it adds to the ‘top line’. It is cash we need to generate.

Finally, in agreeing terms, it is good, wherever possible, to try and arrange not only billing patterns, but also payment plans. If these are included in the terms of business it is much harder for the client to resist the bills that are delivered – and remember, your clients are seeking certainty around their own cash management. It can make it easier for them if the quantum and timing of bills is agreed in advance. In some cases, it will also be highly desirable to have some cash from new clients upfront.

Performing the work

We’ve agreed the terms and formally accepted the instruction. Now we have the second opportunity to lose money.

Professional practices are ‘people’ businesses at their heart, and it is their time that is being sold. This is not just true when the assignments are charged on a time-basis – that is just a mechanism for agreeing a value for the work - so it is important to understand the duration partners and staff are spending on client assignments. Experience tells us, however, that in the majority of circumstances, we don’t actually record all the time we spend dealing with client’s affairs.

Where fee arrangements are on a time-basis, for each unit of time we don’t put down on the timesheet we are arguably giving the client a discount. Some may argue they do this because they only want to record what they believe they can justifiably bill. The counter-argument is two-fold. If that decision needs to be made, why not make it when raising the bill? Second is that the person under-recording their time might not recognise there has actually been value in that time they have not recorded. A fee-earner has been presented with a problem by a client, and in arriving at the possible solution they have considered various scenarios, some of which may have had to be discarded. Should the time spent on those options be recorded? I would say yes, as they were an essential part of arriving at the final solution. Some, I am sure, will consider that it was a waste of time because it didn’t lead directly to the solution.

Earlier I mentioned that clients are buying our knowledge and experience. Very few of us turn off our brains when we turn off the light as we leave the office, and we will continue to think about client matters when we are travelling into the office, at home (supposedly relaxing) and at various other times. It can be at these times we have the ‘eureka’ moment in fact, but again, how often do we record that extra time we have spent finding solutions for our clients?

Is this as important when dealing with fixed-fee arrangements? The answer must surely be yes. It should help us assess whether the quote we gave to the client was appropriate, and provide us with experience for pricing similar work in the future. If the additional time spent was down to the actions of the client or because additional work was required that was not anticipated at the outset, at least there is a platform there for discussing additional fees with the client. There is a similar argument for making sure that all time is recorded on conditional and contingent-fee assignments.

Billing the client

What should be one of the most satisfying aspects of being a partner in professional practice can often become difficult and deeply unsatisfying. It is a time when relations between client and their advisors can become strained, and also provides the third opportunity to lose money. The reason, normally, is down to an expectation gap.

If the agreement of terms have set down the billing arrangements the process hopefully becomes easier, but there will still be a number of questions to address. For example, what am I seeking to bill the client for and what charges are they expecting? At this point it can be a helpful exercise to put ourselves in our clients’ shoes and consider what their reaction will be when they open the envelope and read the fee note.

One issue that frequently causes problems is when advisors react speedily and efficiently to provide clients with solutions, but then delay billing the client for that work. By the time the bill arrives the client has forgotten how worried they were and how grateful they were when provided with the solution. The best time to bill a client in these circumstances is as soon as the advice is delivered and the client is feeling relieved!

The lesson here is that it is not just the quantum of work in progress (WIP) that should be monitored, it is the ageing – and that does not become more billable the older it gets.

From a management perspective, it is important to understand the recoveries that are being achieved on bills, i.e. for every £1 in WIP, how much is being billed to the client? If there is £10,000 in WIP and the client is billed £9,000, the recovery percentage is 90 per cent. On the face of it, this may be acceptable, but if there is unrecorded time of £2,000, does that mean that the recovery should only be 75 per cent, or is it the case that the client would have been billed 90 per cent of the total time costs of £12,000 (i.e. £10,800)?

Even if all the time is recorded, there is often a temptation to second guess what the client’s expectations are and still end up underbilling. So using the above example, if the client was billed £8,500 (being a recovery of 85 per cent of the recorded time of £10,000), the loss of value through under-recording time may be compounded by then accepting a lower recovery than might have been achievable.

Collecting the cash

This is arguably the most important element of the revenue cycle, but one that can often be ignored by partners.

Some questions to be considered here include: how long did the client take to pay? Did they query the bill? Have you needed to raise a credit note or offer a discount to secure payment? The answers here should provide valuable experience in understanding the relationship with the client, and providing a basis for agreeing the terms for any subsequent instructions.

Although most firms will have a dedicated person or team dealing with credit control, the primary relationship with clients is through the partner, and they must take some responsibility for ensuring that the bills are paid. They will, however, need to have access to accurate and up-to-date financial information to make sure they are aware which clients have bills that are overdue and the extent to which there has already been communication with them. Finally, management needs to play its part by providing the impetus and focus for partners to concentrate on this area of the working capital cycle.

In summary, partners can play an active part in the management of the firm’s working capital by:

Knowing their clients and being robust in deciding whether or not to accept an instruction;
Agreeing the terms for the assignment upfront;
Recording all the time involved in the assignment;
Billing promptly and, if applicable, regularly;
Ensuring the bill is paid promptly.

Steve Gale is an audit partner in the professional practices group at Horwath Clark Whitehill LLP. He can be contacted at: steve.gale@horwath.co.uk