As accountants, we often coach clients on the difference between profits and cash, yet our firms are sometimes profitable but saddled with debt to support clients not paying on time.
Traditional compliance and advice services reflect costs being incurred (WIP) before an invoice is issued (WIP becoming a debtor). The combined lock up (WIP plus debtors) can stretch to a third or quarter of a firm’s revenue – 3 to 4 months’ income tied up in debtors and WIP. The average figure per the 2014 GBU is 88 days.
For a firm with a turnover of $2.4m, debtors alone can amount to $400,000 at a profession average of 61 days.
This means that cash that can be used to reduce debt, invest in improvements to the firm or be distributed to the firm’s owners is sitting in the bank account of clients rather than the bank account of the firm. It represents work already done for which the firm should have been paid.
Why is your money in someone else’s bank account?
Few of us like calling to ask for money. Many partners are reluctant to risk damage to client relationships through regular requests for money. There needs to be a bridge between clients needing time to pay and the firm’s right to be paid now.
Fee funding bridges the gap between a firm’s right to be paid today and the desire/need of certain clients to enjoy extended terms. Coming at no cost to the firm, fee funding can help selected clients.
A firm is comfortable having let debtors build to a level where cash coming in and debtors being added are matched. There is still an excessive level of debtor balances but having borne the cash flow cost of creating the debtors book, the firm is comfortable. Elsewhere in the Good Bad Ugly there is discussion of the continued decline in the fees clients will pay for commoditised compliance work. This margin squeeze makes it less affordable to be consuming margins with bank interest accrued through giving clients credit. This cost must be reduced.
The true cost of this cash flow dilemma is:
– Increased interest cost to the firms and its owners;
– Higher risk of bad debts;
– Missed opportunities to provide further services to clients; and
– Less positive communication with clients.
Let’s look at these a little more to see what they are really costing.
The most obvious is interest on borrowed funds. At say 8% on the overdraft, each 30 days is costing a firm the equivalent of $32,000 annual interest, which represents approximately 180 hours of partner return on effort.
The longer a debt is outstanding, the lower the probability of it ever being collected. Put simply, your long overdue debtors have used your money to pay someone else or themselves and now have less money to use to pay you. We all have stories of clients saying they cannot pay their accountant because they are away on holiday – your money paid for their holiday!
Bringing debtors in fast through a systematic approach to collection is simply moving you up the pile and moving someone else down. Unfortunately, when a client needs their accountant only once or twice a year, moving up the pile is harder. Having a monthly payment option – whether through a process you administer or through fee funding – turns your payments into a regular monthly payment rather than an infrequent “forgotten” payment.
Any service provider would be reluctant to provide further services when a client has not paid for the work done to date. Accountants are no different – we typically say no to further requests from clients with overdue accounts. If those accounts had been paid, we would be happy to accommodate future request and may even proactively offer the client additional services of the type described in other parts of the Good Bad Ugly. You can use fee funding at the start of an engagement to ensure you are paid upfront before work even commences. It can also be used at the time of “pitching” for a new client or submitting a proposal to an existing client. Language like “we can offer a monthly instalment option to make our advice more affordable” will win further business for your firm and remove “sticker shock”.
So in summary, the true value of accelerated cash flow includes the intangible benefit of improved client relationships and the very tangible aspect of money in your bank account and increased firm valuation from increased revenue.
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