Just when Jim thinks he has the firm under control, he finds he owes $50,000 more in taxes, has a $60,000 backlog of vendor bills, and has $80,000 in outstanding invoices clients have not paid. What did Jim miss?Jim only focuses on the here and now and has not developed plans for the future. Developing a forecast is hard work, but critical for the success of any business!
While these stories are based on real situations, the characters and details are fictitious. Any similarity to any person living or dead is merely coincidental.
Scenario
Jim launched his law firm over 8 years ago and has been doing fairly well with a team that includes himself, an associate, a paralegal and a part-time bookkeeper. He is very detailed in his work, has a long success record and gets a lot of referrals from current clients. Jim works over 60 hours each week and bills close to 60% of his time. He looks at his bank balance every morning so that he can then tell his bookkeeper Jonna which bills to pay that day. His tight watch on the bank account and knowing that the firm is cash flow positive calms his anxieties. Client invoices are entered into QuickBooks and all clients are invoiced on the first day of each month for their first billing. Jim is very hands on with the firm’s finances, spending up to two hours each day making sure Jonna enters expenses, pays the bills he has identified for payment, and collects outstanding invoices. Jim feels he is doing an excellent job managing firm expenses and billings. Jim’s sole focus is on the day-to-day activity of the firm and, in his mind, has no need for planning the firm’s future growth and profitability.
By the end of the year, Jim sat down with his CPA to review his tax situation and was shocked to learn that the firm had outstanding vendor invoices of $60,000; an accounts receivable balance of $80,000, with 50% over 90 days; and, owed $50,000 more in taxes than he anticipated. Jim was unable to comprehend how this had happened when he believed he had such tight controls on finances and the firm’s bank account. His CPA walked Jim through the firm’s profit and loss, balance sheet, accounts receivable, and accounts payable statements. Jim felt overwhelmed, defeated, and completely at a loss as to what to do next.
Core Issues
Jim has a high need to control each and every detail of his law firm’s operations. While that attention to detail makes him an excellent attorney, Jim is losing on two fronts. First, he is giving up 8 hours of billable time every week to essentially do the firm’s bookkeeping, something he pays Jonna to do. This means he will miss the opportunity to bill revenue of $125,000 over the course of a year. Second, his here and now focus limits his ability to see the full financial picture, to plan for the future, and to allow others the chance to contribute and make an impact on the firm.
- A One Man Show. It is not unusual for a founder to have 100% control over the numbers. Jim was a political science major and then went into law. Jim is a very likable guy who finds it easy to manage all facets of the firm’s operation and while these attributes help him with client development and retaining clients, his approach is causing serious harm to his firm’s financial health. Jonna is an experienced bookkeeper with extensive skills who trained for several years with a finance expert. Jonna wanted to work part-time and has been willing to deal with being micro-managed, but is growing frustrated over Jim’s refusal to let Jonna help him free up his time, see a complete financial picture, and develop future plans for growth and profitability.
- No Planning. Planning is not easy and Jim didn’t like the uncertainty of putting numbers down for future months. Jim knew which recurring bills needed to be paid each month, such as rent, payroll, taxes and office expenses, and what he wanted to take home. Where Jim failed to focus was the firm’s other nonrecurring bills such as expert witness invoices, advanced client expenses, and marketing expenses. Jonna tried to alert Jim to these expenses and the mounting accounts receivables balance with the resulting collections issues. Jim made basic assumptions about his personal tax liability based on the firm’s previous year’s income but failed to realize that Georgette, his associate attorney, had billings that were up 20% over the prior year. To complicate matters further, while Georgette was billing more, her client base was made up of start-ups and entrepreneurs who are notorious for being slow payers.
- Unmanaged Collections & Payables. Jim focused on what payments were coming in the door and what payments were heading out. While Jonna knew the firm’s, clients were falling behind in paying their invoices and the firm was facing outstanding vendor bills that needed to be paid, Jim would not look at those reports Jonna prepared from QuickBooks. Georgette’s clients were falling further and further behind on their invoices further contributing to the firm’s growing accounts receivable balance. Georgette and Jonna would frequently discuss collection strategies; however, Jim refused to participate in those discussions, relying only on the bank account balance. Jonna felt alone in her efforts to manage payables and would frequently run payables reports knowing that the balance, like receivables, continued to grow. Each week, Jonna would email Jim the reports but he never responded nor addressed the reports.
Solution
Jim’s controlling nature has its advantages but, being controlling also has a downside. Jim’s team members feel as though they cannot contribute because “Jim does it all.” The first thing Jim needs to do is slow down and assess the talent around him. He chose these talented team members and now he needs to let them do their jobs and take on more responsibility.
- Step by Step Process. Jim will need a step-by-step process in order to let go of micromanaging the firm’s finances. He needs to start trusting Jonna. It will take Jim approximately six months before he changes his need to view the firm’s bank account daily. Within a year, Jim will start billing more and start trusting Jonna and Georgette to manage more of the collections and payables. Jonna will bring in a finance person who she knows from her last position to do the following:
- Review the financials and guide Jonna in developing a forecast.
- Walk Jim through the process each week, then every other week and then monthly.
- Develop critical weekly reports so Jim knows the amount of cash is in the bank
- Develop policies and record keeping that keeps the team informed on the status of the firm.
- Planning out the Future. Jonna’s finance person will know exactly how to structure discussions, forms and meetings in order to guide the firm to look into the future. Jonna has been part of forecasting for years and feels she can develop the forecast with this guidance.
- Structured meetings on revenue, expenses, when to pay bills, when to alert Jim to issues, identifying trends, and creating a decision process where important metrics are part of the process will be critical to getting Jim on board, billing more hours and doing less around the financials.
- Making sure the balance sheet and all the accounts receivable, advanced client costs, accounts payable, loans and equity account are in order. The balance sheet did not reflect Jim’s personal credit cards he used for the business from time to time. Jim needs to capture all of his expenses so that it can be reflected on the expense side of the P&L as well as a loan on the Balance Sheet.
- Collections Management. While it is true that Jim knew what his clients owed, he did not know what Georgettes clients owed nor has he ever looked at an Accounts Receivable report. Jonna, guided by her finance person, needs to develop an alert plan on what happens when a client is 60 days past due. In addition, clients were not billed every 30 days if the invoice was not paid. Jonna changed the billing cycle immediately and added a 1.5% late fee for each month past due. The changes in collections policy also needed to be in the client contract, so the current clients were exempt from the new policy on all past bills. Jonna’s only recourse was to call the clients every two weeks and to have Georgette do two things: secure higher retainers up front, an alert the client when overdue with follow up every two weeks
By implementing these solutions, the next 12 months will run smoother. Cash will be managed more effectively and surprises will be dramatically reduced. Jim will be able to bill more hours and start to appreciate the contributions of his team.
Why Forecasting is Critical
If you were traveling to a somewhat familiar area but didn’t know the actual road names or exactly where you needed to turn, wouldn’t you use a map or mapping tool such as Waze or Google maps to guide you? Without a forecast, Jim was burying his head in the sand and refusing to face the future of his law firm. A forecast helps managers make better business decisions. An informed manager knows where the business is today, where it is heading in the near future, and how to manage expenses based on collected revenue and timing. While forecasting takes time and some expertise, it will allow lawyer managers the ability to know the following:
- When it is appropriate to increase expenses, such as a when hiring a new employee, planning to purchase new computers, or even move to bigger offices,
- What amount to put aside for state and federal taxes,
- What cash amount needs to be collected in the future, which correlates to how many hours to bill a week and at what rate.
- Which clients would be best for the long-term health of the firm.
- Which marketing vehicles are best to get business – is it the internet, referrals, or speaking engagements? Of these, which brings in the highest long-term revenue potential?
With a forecast, Jim could have been armed with all the information he needed to make better decisions. Forecasting is not only important for the direction of the business, it can save tens of thousands of dollars. Firms may need to spend four to six weeks developing a budget for the next twelve to eighteen months with a finance person who can analyze and question the assumptions. The budget forms the basis of the forecast. Instead of hiding the budget in the desk, it should become a living document. Each month, the actual numbers are entered and the managing lawyer works with the finance person to decide future revenue, expenses and sources of cash. Within a few months, the process will become common place and the law firm will experience a maturity that makes all the difference in growth and profits.