Control of working capital: Every managing partner’s nightmare?

Billing and cash collection are essential components of the successful business. Law firms, however, have a long history of getting it wrong due to a lack of fee-earner accountability and a piecemeal approach to the billing process. Laurence Harris, chief executive at D J Freeman, examines the steps his firm has taken to streamline and control the firm’s working capital.

If there were such a thing as a school for managing partners (which, perhaps fortunately, there is not), the first lesson of every Monday morning would doubtless be devoted to the critical issue of working capital control. After all, law firms are cash businesses that should be simple to manage. Their primary asset is their people who charge for their time (usually only in two or three different ways), and the bills are then collected. Simplicity is not, however, the lesson that this novice managing partner has learnt.

The speed at which the firm’s time is billed and paid by clients is critical to the firm’s working capital requirement and thus to its overdraft or long-term debt position. Anything that can be done to improve the speed of billing out and collecting in has a direct and significant impact on the firm’s cash position, profitability and the firm’s need for external funding.

While I do not hold out that D J Freeman has achieved perfection, we have been able to significantly improve our working capital position over the last 12-18 months by a mix of four tools that have, taken together, really helped us.

They are:

A new practice-management system;
Changes to our credit-control department;
Motivating partners to help crack the issue;
A system of reviews ultimately involving the finance director and I, which demonstrate the firm’s top-to-bottom commitment to this issue.

None of these tools are unique to us and none by themselves make the difference, but we have found that taking the four in combination has considerably improved what we have been able to do in working capital control.

An empowering practice-management system

In 1999, under the leadership of my predecessor, Jonathan Lewis, the firm became the first UK legal practice to implement the Keystone practice-management system. The implementation of the system was the first step in our drive to significantly improve our working capital control. The key change that has enabled this to happen has been the transfer of responsibility from the accounts department to each fee-earner and secretary’s screen, particularly in relation to time recording and billing. All fee-earners now record time daily on screen rather than weekly on paper as with our previous system. This system of daily-time recording works well. We have found that fee-earners entering data directly into the system has reduced many potential errors, including faulty transcribing of matter numbers and descriptions, and misplaced timesheets. The managers of each practice area also have a much more accurate real-time picture of how resources are used and who is not up to date with their time recording.

This has significantly improved our information flow and gives our finance director and those partners who review the finances of each practice area of the firm, much greater versatility in undertaking their roles. Getting data out of our old system was problematic and sometimes it was out of date. With Keystone, we get instantaneous real-time data that makes the job of reviewing a department’s billable hours, time recording, matter balances and even chasing old bills much easier.

The really big change came with on-screen billing. First, it enabled a much speedier preparation and processing of bills, allowing a lot of the billing to be done right at the end of a month to encompass all time up to the point of processing the bill. Second, the integration of the time recording and billing systems enabled us to deliver to clients full narratives for every bill, setting out how each and every piece of time spent on the job has been incurred.

These breakdowns of time and disbursements have eradicated a significant number of billing queries that we used to get under the old system, where producing detailed narratives to accompany a bill was a manual and time-consuming task. At the time of implementing on-screen billing, we also implemented various checks and authority levels that prevent significant time or disbursement write-offs without appropriate authority.

A further innovation, introduced last year, was the “openbook” module, a purpose built add-on that we designed with Keystone. This enables clients to have real-time access to see work in progress and rendered bills on their matters, via a secure site on the internet that goes into the practice-management system. This even greater degree of transparency has further allowed us to cut down on the billing problems that inevitably occur from time to time.

Although our practice-management system has allowed us to make substantial strides forward, it has, as with any new system, brought forward new and unanticipated problems, some of which are not straightforward to tackle. For example, delegating file opening to the individual fee-earner or secretary is great in relation to getting a file number straight away to charge time or disbursements to, but not so great in relation to keeping tight control over the creation of client entities to avoid duplication. The Keystone system has shortcomings in certain areas, which we have had to work around. Equally, its marketing module does not provide us with as sophisticated a database tool as we would like.

While our implementation of Keystone has not been trouble free, the real and lasting impact has been to give us the tools to improve the control of our working capital – it is easier and faster to bill it and there are fewer queries when we do.

Having the tools to do the job, however, is only half of what is needed – in fact, probably rather less than half. The key tasks are then to get people to use the tools now at their disposal and to change partnership attitudes to billing and collection.

Credit control

Like a number of firms, I suspect we have experienced the usual tensions between partners and credit control in the past. Concerns about whether credit control would damage the client relationship led to a reluctance or a simple refusal by the partner to hand over the bill that needed chasing to credit control. Partners are not, by and large, particularly effective in the role of fee negotiation and collection, so we were considerably less efficient in this area than we ought to have been.

In light of this, we significantly up-graded our credit-control facilities, recruiting an excellent credit-control manager to head that function. Sallie Redmond’s involvement goes far beyond just collecting bills. She attends all the internal financial review meetings within departments, takes responsibility for seeing those partners with greater levels of locked-up working capital, both to look at their work in progress and their bills on a regular basis. By undertaking that role, she and her team have built up sufficient confidence so that partners are now usually happy to hand over to Redmond and her team, the collection of bills that go more than 30 days without payment. They can be sure that they will do it better than the partner concerned and will not make the client relationship more difficult in the process. A key factor to making the process work is that Redmond has taken time to build relationships with partners to the point that they are happy that their client relationships will not be jeopardised by over-zealous credit control chasing. We have found that, while professional credit controllers are much more effective than partners in collecting outstanding bills efficiently, they have often been unable to establish these successful relationships. It is sometimes critical to involve the partner in unblocking a jam that is preventing payment, so it is essential that credit control works in partnership with the responsible partners or fee-earners to try and get the bills collected as quickly as possible.

Effective work by credit control means that we hear very quickly of problems where, for example, bills were not sent out promptly after being drawn or further input is needed from the partner before the clients will pay the bill. Most importantly, we have an efficient system for the collection of all our bills after 30 days and we know that the vast majority will come in quickly with a bit of chasing from credit control, leaving us to spend most effort on the more difficult bills.

Any problems quickly move to a departmental finance partner who is responsible for ensuring that he or she has a handle on all the bills that may prove difficult to collect, where there may be a significant delay in collecting them and where he or she can get involved with the partner responsible for the matter to try and unblock the problem.

So far so good but we are still left with a big problem: getting the work in progress billed out in the first place. Billings that are based on time and billed on an interim, monthly basis are always the most straightforward to bill out regularly. Much of the firm’s contentious work is billed on a regular monthly basis and control of this work in progress is usually straightforward. Transactional work is not so straightforward and requires constant pressure so that we keep work in progress under control.

Partner buy-in

Good systems and effective credit control get you so far, but partner buy-in is the most critical element. In our firm, a partner is responsible for every open file in the firm. Getting them to take responsibility for those files, and making sure work in progress is billed promptly, is critical to us making progress generally. Twelve months ago, we instituted the publication of monthly figures listing all partners with the total amount of work in progress and debtors to their name, broken down by ageing. This “league table” is circulated to all partners, every month, and everybody has a target to achieve. This ensures that no more than 50 per cent of their work in progress and their debtors are more than 30 days old.

This is a tough target to achieve and so far, our best monthly effort had very nearly half of all partners achieving this target. What is more important to us is

to look at whether people are improving on a month-by-month basis, and also whether the total lock up is improving. In this respect, the figures have shown a marked improvement throughout the year as most partners have really begun to focus on their individual balances and have tried to improve their standing on the league table.

As an added incentive, we introduced a system of amber and red lights. Partners with significant balances who could not show that they had improved on a month-by-month basis would get an amber light. Further deterioration would generate a red light and a review meeting with me and our finance director and, ultimately, the threat of financial penalties. So far, although we have had a few meetings with individual partners, we have not yet had to take the draconian step of imposing a penalty, as improvements have always been forthcoming.

This whole system, particularly the amber light/red light element, was introduced after a discussion and the agreement of all the partners. There was a collective feeling that we really should manage our working capital better and that we all had to buy into doing this and accept there was a penalty if we did not. Without that collective buy-in at the start, very much doubt whether this initiative would have been successful.

Pulling it all together: Accountability and involvement from the top

We have established a simple system of interlocking responsibilities and reviews throughout the firm to enable two things to happen:

We are able to identify the difficult areas and concentrate our collective firepower on them;
We are able to demonstrate to the whole firm that everyone, from the chief executive downwards, is really committed to making our performance in this area first class.

Ultimately, efficient control of working capital is, I hope, being subsumed into the culture of the firm at all levels. How do we do this?

First, each fee-earning department has a finance partner who takes responsibility, with the departmental head, for the budgeting of the department (each department is its own profit centre), and then for billings and collections. The style each brings to their department is slightly different but the way they operate is very similar.

That responsibility starts at the inception of matters. The finance partner must approve any unusual discount, billing or collection arrangements. They will also oversee the operation of new-client procedures and quickly identify possible problems. This remains an area of weakness, and we have recently strengthened our file-opening procedures to try and reduce and control the risks we take in deciding to act for particular clients and, if so, on what terms.

Each department has a system of print-out reviews for every fee-earner in collaboration with credit control. The departmental finance partner takes responsibility for understanding when the larger transactions are going to be billed.

These systems mean that there is some external check on each partner but from within their own department so that these checks can be managed in a friendly and collegiate manner.

Every month, the finance director, credit control manager and I have a financial review meeting with each of the department heads and finance partners. We review major work in progress and debtors, and pinpoint actions to be taken. Sometimes those meetings, or the monthly partner league table, highlight a particular problem. Then the finance director and I will meet the relevant partner to discuss how they are going to tackle the issue. Our willingness to get involved is well known and understood by the partners, and I hope it underlines the firm’s commitment to perform outstandingly in this area. Ultimately, we are attempting to change our culture sufficiently so that most intervention is preventative rather than post-problem. In this we have had some successes, but we still have a way to go before we achieve this goal.

Of course, there is a personal penalty for this as well. I continue to spend about half my time fee-earning, which means that I need to manage work in progress and debtors. I am very conscious of the need to ensure my own balances are kept well under control. Fortunately, the clients for whom I act tend to be fairly understanding when I tell them that I might have to impose a financial penalty on myself if they don’t settle their bills quickly.

Has it worked?

Has all this, taken together, been successful? I have no doubt that it has had a very significant impact on the firm’s cash position. We are not as profitable a firm as we would want to be but I know from the inter-firm comparisons that we subscribe to, that our performance in this area is among the best of all of our peers. For us, that means that over the last few months, in a worsening economic climate, our capital requirements have been reducing. When I was elected in November 2001, we set ourselves the target that within 18 months, we would achieve a position where our business is funded primarily by partners’ capital (which is in line with mid-sized City firm averages). By that stage we wanted to be operating only a net-nil overdraft facility (used only for the key payments during a financial year and otherwise with the firm being in credit) and have no long-term debt. As things currently stand and even given the uncertain outlook, we are well on course to achieve this by around 30 April 2003, the end of our current financial year.

Laurence Harris is chief executive at D J Freeman. He can be contacted at: laurenceharris@djfreeman.com.