By Gene Commander
Gene Commander, Inc.
As we enter the fourth quarter, it’s time for Colorado law firm leaders to examine their firms’ key financial performance indicators for 2023, and to develop strong financial plans for 2024 and beyond. The door is still open to maximize profitability for this calendar year, and it’s an opportune moment to consider innovative business strategies to set the stage for continued prosperity.
Taking stock of a law firm’s financial health and crafting deliberate strategies to address fluctuating client and talent expectations are essential elements of a smart growth business model – one that is designed to foster continuous learning, growing and investing in human capital to confront the current uncertainty in the business of law. The Colorado legal market is facing high inflation and interest rates, shifting client demand and a potentially crippling price war for talent, as national firms play a larger and larger role in Colorado’s legal industry. Moreover, demographic, educational and professional trends are causing profound workforce changes as baby boomers retire, younger lawyers move into leadership roles and attrition rates grow. Indeed, the recent State of the Law Firm Survey in Colorado found that over a quarter of respondents planned to leave their firm within three years.
Now is the right time for Colorado law firms both to enhance their cash flow management and billing practices and to set informed budgets and investment strategies for the year ahead.
Disciplined Cash Flow Management and Billing Practices
At the outset of the fourth quarter, it’s critical for law firm leaders to undertake a thorough analysis of their firm’s cash flow. Firms should invest time and effort in taking an honest look at year-to-date cash receipts from client matters when compared to the firms’ 2023 income budget and year-end revenue projections based on unbilled but collectible work in progress and collectible accounts receivable. For unbilled work in progress through Sept. 30, firms should promptly bill clients, or reconsider collectability and make appropriate adjustments through write-downs or other accommodations to reflect the value of the unbilled time more accurately for future collections.
For accounts receivable, firms should either devote the effort required to collect their invoices between now and Dec. 31, or determine whether it is necessary to write off some or all of the outstanding account balances to maximize the return on their collection efforts and accurately forecast future revenues for the 2024 budget. Any accounts receivable over 60 days old should receive personal attention from the billing attorney as soon as possible so the receivables can be turned into cash receipts prior to the close of the year. In fact, some clients will be grateful to get bills off their books before the end of the calendar year.
Experience shows us that receivables over 90 days old at the end of the year are unlikely to be collected in the first quarter of 2024 – typically the slowest collection period of the year – and the present value of receivables over 180 days old is unlikely to ever be recovered in full. Unfortunately, experience also tells us that default interest provisions in firms’ terms of engagement seldom provide an adequate remedy when receivables are allowed to age beyond 180 days.
Collecting cash receipts before year’s end will maximize profits per equity partner and enable firms to make greater profit distributions at a time of year when personal financial commitments may be adding up for talent throughout the organization. And a robust financial showing for 2023 will enable firms to reward productive talent with raises for 2024 that will keep them happy and invested in the firm.
Attending to cash flow in a thorough and transparent manner prior to year’s end will also enable firms to make realistic revenue projections and set reliable operating and capital budgets for 2024, upon which dependable levels of compensation can be set for all talent for the coming year.
Law firm leaders cannot afford to overlook the critical importance of sustaining disciplined billing and collection practices year over year. Law firms should ensure they have procedures in place to promptly bill their clients, both to smooth cash flow and to prevent undue surprises on their clients’ part. Further, Thomson Reuters observes that in addition to experiencing declines in productivity, law firms are broadly suffering from reduced realization rates – the percentage of revenue collected compared to the revenue that law firms would have earned if they had billed and collected their standard rates for the hours of work actually performed.
A significant contributor to this costly trend is excessive write-downs. Firms routinely write down a sizable portion of associates’ billable time before invoicing clients for the services rendered, perhaps because partners are concerned about client expectations. Yet lawyers often cut bills that clients would willingly pay. There are effective ways to mitigate this chronic problem. In addition to examining the root causes for attorneys’ billing concerns and adjusting their expectations about how much time is appropriate to write down, firms should make ongoing investments in the training, mentoring and advanced technology that will help all attorneys to work more efficiently so that firms feel less need to write down billable time.
Informed and Dependable Budgets
Setting a budget for the coming year demands an accurate projection of future revenue, in part by closing the books on the aged work in progress and accounts receivable from the prior year as part of the cash flow analysis recommended above. Further, honest conversations with partners about realistic billing, collection and realization levels for the coming year will provide valuable input to the budgeting process and allow firms to capture a true picture of their financial condition. In doing so, firm leaders must critically evaluate partners’ personal and practice group revenue projections to verify how those projections stack up against past performance. The consideration of three-year rolling averages based on prior billable hours, personal cash receipts and realization rates can be an effective budgeting tool for the coming year.
When setting budgets, law firm leaders must take a careful inventory of expenses but should resist the temptation to make short-sighted cuts. Major overhead expenses – including salaries, facilities and technology – are untouchable for most law firms because they are vital to firms’ ability to provide first-rate services to clients and to retain top talent.
Despite their understandable concerns about the growing costs of doing business, Colorado law firm leaders should double down on their existing talent. The cost of losing human capital can derail even the most thoughtful firm budgets and business strategies. Further, if firms temporarily find themselves with more capacity than needed to meet current client demands for legal work, firms should treat this as an opportunity to invest in their talent’s skills and to explore new practice areas to grow their revenue potential. Doing so can optimize talent’s productivity, allowing firms to flexibly respond as client needs shift toward different areas. Moreover, this form of ongoing career development will help firms foster a magnetic workplace culture where lawyers want to stay, which is essential given looming talent shortages.
In their annual budgeting process, firms should consider the possibility of raising billing rates. Firm leaders may worry about whether higher rates will be acceptable to clients. But for a number of firms, rate growth has fallen behind the inflation rate and market expectations. While prices have soared for most professional services in recent years, billing rates have stagnated in many Colorado firms.
Before deciding to raise rates, law firm leaders should carefully analyze the economy’s potential impacts on their future costs of doing business and confer with partners to determine whether they received billing pushback from clients in 2023. And it would be wise for leaders to dig still deeper by researching market conditions to determine whether reasonable rate increases are justifiable and talking to trusted client representatives to assess whether rate increases would be palatable. When considering this option, law firms can take some comfort in knowing that record numbers of their peers and competitors upped their rates in 2023.
Setting the Stage for Growth
By drawing on these recommendations, Colorado law firms can finish 2023 in a strong financial position and set themselves up for sustainable financial profitability and professional success in 2024 and beyond.
– Gene Commander has more than 40 years of experience in the legal industry while practicing construction law with small, midsize, regional and national firms. He formerly served as managing shareholder in the Denver office of Polsinelli PC, an Am Law 100 national firm. Gene is now an executive business counselor for the legal and construction industries, with a special focus on business growth strategies for Colorado law firms. He can be reached at [email protected].