This is a busy time of year. With all the hustle and bustle of the holidays, it’s easy to lose track of all you need to do to close out your year. Because most firms make profit distributions at year-end, firm management needs to have complete and accurate financial reports to help project December cash flow while also looking ahead to 2018. So it’s important to review and understand your law firm’s financial position before December 31 so you can plan accordingly.
While most of the following procedures should be followed throughout the year, you should give them extra attention at year-end.
- Prepare a cash flow projection to estimate cash on hand as of December 31 – The projection should take into account December operating expenses, older vendor payables, pay down of firm line of credit, staff bonuses, unusual year end cash disbursements, reserve for capital improvements, retirement plan funding, quarterly tax payments and profit distributions to equity partners. In addition, the firm needs to make sure it has sufficient cash on hand and an adequate line of credit to cover first quarter 2018 firm operating costs when cash collections are at their lowest.
- Require all timekeepers to release hours worked as of the end of November for billing in early December – Making sure all timekeepers are current with time entry is critical for year-end billing and collections. A key metric for law firms is billing realization (the percentage of billable hours and fees that actually get billed). Most law firms should have a billing realization goal of at least 90%. However, the later you bill, the more time you lose. Studies show a 14% drop in billing realization on hours billed in 60 days versus 30 days. The percentage increases to 35% when hours are billed after 120 days versus 30 days.
- Review Work in Process (WIP) aged report and identify billable fees as of November 30 – How much unbilled WIP is in your 60 day, 90 day, and 120+ day bucket? This is the time of year to review every aged balance to determine if it is billable or should be written off. You want to go into the New Year with a clean WIP balance. Extra effort should be made to make sure all billable time has been invoiced by December 15. Clean up your aged WIP report by writing off unbillable time due to fee discounts and inefficiency write downs. A good rule of thumb is that you want less than 2 ½ months billings in total WIP. Also if more than 15% of your WIP balance is over 180 days, that’s a red flag.
- Review accounts receivable (A/R) aged report for old outstanding balances – As invoices age, the less chance you have to collect the full value. When collections are sped up from 90 days to 60 days, the likelihood of collection success increases by 15%. When invoices pass the 180 day mark, there is only a 44% chance of collection. If more than 25% of your A/R balance is over 75 days old, it may be a red flag. Prepare a list of large and/or old (over 90 days) outstanding unpaid A/R balances. Distribute the list to each responsible attorney and hold them accountable for collection. For any accounts deemed uncollectible, write them off as of December 31.
- Review status of retainers – Retainer balances need to be large enough to cover anticipated work and expenses to the end of each billing period. Where necessary, request replenishment according to the firm retainer policy so that there are sufficient retainers on hand as of December 31.
- Reconcile IOLTA balance on books with trust bank account – A lot of firms mismanage IOLTA accounts. IOLTA (Interest on Lawyers Trust Accounts) accounts are defined as unearned client funds reasonably anticipated to be held for a short period of time. Once the fee is earned, it must be withdrawn from the client’s IOLTA account and transferred to the firm’s operating account. IOLTA balances reported on the balance sheet should be reviewed by December 31 to make sure they reconcile to the IOLTA bank accounts and agree with the firm’s subsidiary ledger detailing the balance by client.
- Review unreimbursed client expense advance account – Some firms record unreimbursed client expenses as receivables, some book them as other income or reduction in client expenses on the profit and loss statement. Per the IRS, they need to be booked as receivables. If you haven’t reviewed the client expense advance receivable account, there may be expenses paid for clients that will never get recovered. You need to write them off by December 31.
- Prepare aged list of December 31 vendor payables for managing partner review – Most firms want the expense deduction in the current year for tax reasons. But this needs to be balanced against the need for sufficient cash going into January, 2018. Review balances with 30-day terms for payment before year-end.
- Request attorney expense reports for reimbursement of out-of-pocket firm expenses by December 31 – Expenses include auto mileage, travel, meals/entertainment, practice development, and professional expenses.
- Review year-to-date financial statements for reasonableness – Before year-end, review the firm balance sheet and profit and loss statement for any unusual, questionable balances that may require adjustments. Compare to the firm budget and the prior-year financials for any material variances. Make sure that year-end adjustments such as depreciation expenses have been recorded.
At the end of the year, it’s especially important to review your firm’s financials as this information will be used to calculate attorney bonuses, partner profit distributions and annual tax returns. Having complete and accurate information will save you time and headaches as you manage the firm’s finances heading into 2018.
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