Credit [crunch] management

‘Credit crunch’, ‘economic meltdown’ and ‘global recession’ are all too familiar expressions. Commercial firms are faced with the reduction of potential business, compounded by restricted borrowing options leading to decreasing available working capital – and law firms are no different. There have already been a number of law firms going into administration and many redundancies, not only of support staff but also of lawyers of all expertise and levels of experience – and this is probably only the beginning of the down cycle.

How can a law firm protect itself against the ensuing economic onslaught? There are the obvious ‘knee jerk’ reactions to downturns – cutting overheads and staff, and these can yield quick and sometimes substantial savings. But what about credit management?

A phrase I often quote is: ‘Good credit management is the key factor that separates those companies who survive and those who don’t.’

So there’s the answer – good credit management. Now, your firm may have a credit management system in place (credit policy and chasing strategies, for example), but when was the last time it was assessed? Is what was created months (or maybe even years) ago and in better economics times, robust and effective enough to carry you through these difficult times?

During these troubled times, firms need to be confident that the debtors ledger will deliver. Unnecessary risk is not acceptable, particularly as the invoices on the debtors ledger represent the entirety of the investment that the firm has put into the client from day one, for instance:

Marketing costs;
Client care;
Legal expertise;
‘Loan’ to the client while the work was ongoing (unless
of course fees came in up front); and,
Overheads – the expenses of all of the above coupled with the staples of rent, rates heating lighting wages, and so on.

So, it is worthwhile for firms to take the time to look into how their debtors are managed. But, managing the debtors ledger is much more than just picking up the telephone – it’s a subtle mix of science, art and, in particular, diplomacy. Credit management should be an integral part of the firm; it should be in line with the culture of the firm, and understood and accepted by its stakeholders. For these reasons, no firm should import an ad hoc policy from another, nor should anyone who has not been involved with the daily workings of the firm impose a model onto the firm without having done research, talked to the staff, analysed the client base and clearly understood the firm’s objectives.

Areas to focus on when revisiting/developing credit management

The easiest, and probably the quickest, way to check if current status and risk levels are acceptable is to analyse the debt ledger.

This is a very simple task. Take the latest list of debtors and have a look at anything over the firm’s credit terms, particularly those invoices that are coming up to double the credit terms. For example, if the standard credit terms are 30 days, look at anything over 60 days, and write down all the reasons for non-payment on each bill.

The general rule of credit management is that people fall into one of two categories:

The ‘can’t pay’ – for instance, the bill will never be recovered (the client may have gone insolvent, bankrupt and so on) or the bill will not be collectible in full for
the short-term (the client may need to pay in instalments
and this of course gives risk to write-offs in the long-term); and,
The ‘won’t pays’ – for instance, the money is there, but for a number of reasons isn’t coming into the firm. Reasons in this category always go from the sublime to the ridiculous.

Once the initial analyses are made, then some searching for ‘root cause’ is needed – and there maybe more than one root. Most firms find themselves looking at areas including:

Marketing – for example, targeting the wrong sort of client;
Client care issues;
Lack of risk assessment;
Ineffective/inaccurate recording of work-in-progress (WIP) or disbursements on the files;
Basic errors on billing; and,
No and/or poor credit control.

Questions to help identify areas that need targeting in order to bring about an effective credit management policy

Taking the above areas one by one, below is a brief outline of the questions that are necessary to examine the current situation within the firm and to identify possible changes of direction, should they be required.

Targeting the wrong sort of client

What types of client does the firm target?
Why does it target these types of client?
How much work do they provide to the firm?
Is that work profitable?
What other firms within the vicinity target the same clients?
In this changing economic climate, should the firm be looking to target a different client base?

Client-care issues

Does the firm regularly ask their clients for feedback?

How many concerns/complaints does the firm get?

How many of the clients have left the firm in the past 12 months and why?

Does the firm make its cost issues clear, for example, payment on account of disbursements or payment in advance of costs?

Does the firm adhere to what is agreed, for instance, respect cost ceilings imposed by the client or levels of interim billing?

Lack of risk assessment

There are two levels of risk assessment: external risk – the risk the practice is taking on when accepting the client’s instruction; and, internal risk – the risk that the client is taking on by asking to you to deal with his case. There cannot be effective client management without doing an all-round risk assessment. Risk assessment is about protection of both parties.

What risk assessments are undertaken by the firm when taking on a new client?
Standard reports or detailed background into the clients?
Is a specific person assigned the role of risk assessor and do they take note of:

Who is behind companies;
What sector a company is in – booming or busting; and,
What sort of work they are asking the firm to do?

Does the risk assessor apply risk assessment consistently?
Does the firm regularly monitor payment histories?
When taking on a client, does the firm check that the expertise to deal with certain areas of law is available, that the right staffing levels exist and that the deadlines can be met?

Ineffective/inaccurate recording of WIP or disbursements on the files

How much has the firm written off in unbilled but chargeable WIP in the past 12 months?
How much in each department and fee-earner?
Why was the WIP written it off?
How much has been written off in disbursements?
Why was the work written off and what is the check on the level of write-offs allowed to be authorised by individuals?

Billing errors

How many bills had to be redone as they hadn’t been sent out? How many invoices have delayed payment or had to have part write-offs because of the following:

The wrong name and or address;
Incorrect client references;
The work having been invoiced too early due to the pressure of fee target, either personal or departmental;
Invoicing not having been done in accordance with the original client agreement, for instance interim billing sent out when agreement was ‘at end of matter’; or,
The invoice delivered was not in line with agreed costs and no one informed the client?

No (or poor) credit control

Is there a specified system of credit control chasing (for instance, a timed chasing cycle, with a set number of actions each one escalating to the next level)?
What methods are used to chase (for instance, letter, phone, statement, e-mail, fax and so on)?
Does anyone assess which chasing methods are best
for which client?
If there are automated credit chasing systems available,
are they utilised effectively?
Or conversely, is there an over reliance on automatic chasing (for instance, leaving it to a machine)?
Is the person performing the credit control effective?
Have they been trained in credit control, for instance, communication skills, time management, basis accounts?
Is credit control seen as an integral part of the firm?
Is there a battle going on between fee-earners and
credit control?
Is there a free passage of information going from the
firm to credit control and vice versa?

All the above questions need to be answered and addressed. Taking them piecemeal will result in a credit management system that is not worth the paper it is printed on. Some firms would leave the redrafting or creation of a credit management policy to the finance department, or maybe a group of partners. It is advisable to have both legal and financial people developing the system, as this way it will keep the policy balanced – the aim being to maintain strict financial controls, but ones that do not strangle the firm so that it cannot function properly.

Training

Once these areas have been addressed, the firm will probably find that it has some training issues to deal with. These could include client communication skills by fee-earners and credit control staff, risk assessment strategies, time management, credit control skills and even a back-to-basics session on how to manage the finances on the files properly, leading to why a firm bills and the importance to the firm of getting paid. For a credit management system to work, it is vital that all the people who will be affected by it – and that includes clients – must understand it.

The point of credit management

There should be regular assessments of the credit management system, from client acceptance through to risk and chasing. After all, there is no point in having a credit policy and then not checking whether it is working or not. And this is a necessity when dealing in fast-moving economic environments or downturns.

Credit management is not a difficult process, and the simpler the law firm makes it, the easier it will be to maintain. But it is, and should be, a key part of the day-to-day management of any practice. It may be time consuming to revisit or create a credit management system from scratch, and it’s understood that it is not a fee-earning activity – but look at what it provides. It is a protection against bad debt – in other words the buffer zone between the possible success or failure of the firm.

Julia Walden is the founder of the consultancy and training company Parkstone Management Co. (www.jwalden.co.uk). She can be contacted at info@jwalden.co.uk