Get Real About Raising Your Firm’s Realization Rate

STEVE LEWIS, CPA

Most law firms spend a lot of time discussing and setting rates, whether they are hourly, flat or contingent.  Ideally, these rates are competitive and enable firms to remain liquid and profitable.  What is less than ideal is the fact that the typical firm realizes only about 85% of the work it performs.  So, in real terms, many firms earn much less than their fees might suggest.

While most firms will never achieve the holy grail of 100% realization, a rate of greater than 90% generally is considered healthy — and within reach.  Here is how to do it.

Reduce Write-Offs

Poor realization is a problem that begins long before you bill clients.  While write-downs sometimes are necessary — for example, when you have promised the client discounts or when a project has taken longer than expected because you are training a new associate — they should not be routine.

To prevent excessive write-offs, make sure lawyers are using time and resources efficiently.  Proper training, communication and delegation can eliminate many of the worst problems.  And if you require lawyers to submit time records daily, you can better control the amount of billable time that slips through the cracks.

Finally, require the billing partner to explain any write-downs that are in excess of a predetermined amount or percentage.  Having to explain such decisions to other partners will help deter the practice.

Getting Off on the Right Foot

When it comes to realization rates, the best defense is a good offense.  First, put fee structure, billing cycle and method, payment term and collections policies and procedures in place.  Then clearly explain them to prospective clients before you begin any work on their behalf.

Exercise particular caution with new clients by reviewing their credit histories and relationships with other firms.  Do not accept new clients that seem like significant risks — no matter how high the potential fees.  If you are on the fence about a client, consider requiring an advance fee deposit equal to several months of work.

Almost nothing is more effective at keeping realization rates high than sending bills promptly and regularly.  To ensure you maintain a schedule, use an electronic payment system that delivers invoices directly to clients, tracks their payments and alerts you when you need to send reminders.

To encourage swift payment, give discounts (even one percent can be a powerful incentive) or value-added services to clients who remit on time.  Consider the same perks for previously delinquent clients that improve their payment histories.

Dealing with Delinquency

Once a bill is past due, an accounts receivable employee should make a reminder phone call.  If the bill remains unpaid, the billing partner needs to talk to the client to find out if there are any issues or objections regarding invoice items.  Before sending an account to collections, your firm administrator or managing partner may want to try to negotiate payment by, for example, reducing or removing penalties, in exchange for immediate payment in full or part.

Although you may not want to accept less than what is due, keep in mind that a collection agency’s fees — or worse, litigation — will limit the amount you eventually recover.  In many cases, it is better to write off part of an account than to let a dispute escalate.

Examine Assumptions

The consequences of poor realization can be severe:  Insufficient cash flow to cover current obligations, reduced revenue and, eventually, discord among partners competing for pieces of a smaller pie.  When setting rates, do not forget to also consider the assumption behind such rates — that your clients will actually pay their bills.

If you have any questions or would like to discuss your firm’s billing and collection practices, contact Steve Lewis.

Why Law Firms Need Internal Controls

KAL SHINER, CPA

Most lawyers know how big a problem occupational fraud is in corporate America.  They may even count as clients’ companies that have been defrauded and suffered significant losses.  Yet a “not at my firm” attitude persists among many partners who take for granted the honesty and integrity of their colleagues and staff.

Unfortunately, given a strong motive and unchecked opportunity, even ethical people can be tempted to steal.  Without comprehensive internal controls, your firm is providing just such an opportunity — and it is likely only a matter of time before someone exploits it.  Even if you have internal controls, if you do not enforce and regularly update them, your firm may be just as vulnerable to fraud as firms that have taken no precautionary measures.

Unique Risks

While law firms enjoy certain protections from fraud, they also harbor specific risks.  For example, on-site management by a team of professional owners can make it more difficult for thieves to carry out elaborate and costly schemes.  But such owners also are more likely to override internal controls.

What is more, work environments where there is considerable pressure to meet ambitious financial and performance goals can turn normally upright employees into cheaters.  And it does not help matters that law firms enjoy a reputation among experienced crooks for having lax controls — or that many firms are unwilling to punish perpetrators because it could lead to bad publicity.

Assess and Address

To prevent fraud risks from becoming reality, closely study your firm’s policies, procedures and processes — including hiring, payroll, billing, collections and IT security — for potential vulnerabilities.  Your financial advisor can help you perform a thorough initial risk assessment and use its findings to create a list of internal controls.  This list may contain hundreds of items, but there are a few that belong in every firm’s internal controls.  For example, it is essential that you:

Screen Employees
When you hire anyone — including lateral partners — perform credit and criminal background checks and verify résumé items related to past employment, education, military service and professional certification.  Keep in mind that, according to the federal Fair Credit Reporting Act, you generally need a person’s permission to run a credit check, and in some states, credit checks are allowed only for positions with certain financial responsibilities.

Separate Duties
No single employee should be in charge of purchasing and approving vendors, or receiving payments and depositing them.  It can be difficult to spread duties among several employees in a smaller firm, so consider outsourcing some accounting functions. You may even want to require that two partners sign checks above a certain amount.

Reconcile Regularly
Periodically reconcile overlapping financial records.  For example, compare receipts that are recorded in your billing system to revenues recorded in your accounting system and then cross-check those numbers with your bank deposits.  Review paper and online bank statements regularly, looking for inappropriate transactions.

Conduct Surprise Audits
Audits do not have to be top-to-bottom reviews of your firm’s finances — they can focus more narrowly on areas of concern such as accounts payable.  To discourage fraud, let employees know that unannounced audits are possible at any time, but do not let them know what data or records the auditors will review.

Training Staff

To ensure that internal controls are effective, make fraud education a priority.  Clearly communicate to attorneys and staff what constitutes illegal and unethical behavior.  Then explain how employees can help prevent and deter fraud by adhering to your firm’s internal controls.  Also specify the consequences of breaking the rules.  For example, an employee who falsifies timesheets may be terminated on the spot.

Partners and managers should receive training in spotting potential perpetrators and suspicious behavior.  People who commit occupational fraud often live beyond their means, are heavily in debt, or have gambling or substance abuse problems.  They may exhibit:

• Control issues, such as an unwillingness to share duties, files or billing records;
• Irritability or defensiveness when confronted about irregularities;
• A reluctance to take vacation or sick days; and
• Unusually close associations with vendors.

To ensure members of your firm speak up about suspicious activity, provide reporting guidelines and a process for investigating such suspicions.

Not Optional

No matter how convinced you are of the integrity of your attorneys and staff, internal controls are a must for every law firm.  By conducting a risk assessment, creating policies and procedures to address such risks and enforcing the rules, you can prevent significant financial losses and public embarrassment.

If you have any questions or would like to learn more about creating or strengthening your firm’s internal controls, contact Kal Shiner at [email protected] or call him at 312.670.7444.

Sidebar:  A Look at Trickle-Down Ethics

The phrase “tone at the top” often is invoked when talking about fraud prevention.  In a nutshell, it refers to how the attitude and actions of owners and managers “trickle down” the ladder and affect employees.

If your firm’s partners talk a lot about the need to act with integrity but do not follow through with their actions, associates and staff will notice.  For example, a billing partner who stresses honesty, yet asks a secretary to pad a deep-pocketed client’s bill with items that typically are not billable, conveys the message that doing the right thing is less important than making money.  Following the partner’s example, the secretary may cut corners — or commit fraud — when an opportunity presents itself.