Are Your WIP and AR Healthy?
Jonathan San Solo, CPA
8.28.19 | Practice Made Perfect
Taking the necessary measures toward assuring the health of a firm’s work-in-progress (WIP) and accounts receivable (AR) is essential to its financial stability. As integral operational areas, WIP and AR require constant attention as they play a large role in maintaining steady cash flow for a firm. By reviewing and analyzing regular WIP and AR reports, firm leadership is able to recognize issues and bad behaviors that may be negatively impacting the firm’s billing practices.
The first issue directly related to projected cash flow is when managing partners and C-suite executives examine WIP and AR, and budget for the percentage they expect to collect. If WIP and AR are overstated, there may be a cash shortfall, especially in the payout of year-end partner distributions. Conversely, if WIP and AR are overstated, the firm may become overleveraged. With these implications in mind, banks often utilize WIP and AR to determine loan amounts or credit facility limits. If WIP and AR are found to be outdated and uncollectible, banks will be less likely to lend money to firms that are, themselves, struggling to collect.
In addition to WIP and AR affecting cash flow and a firm’s debt, analyzing financial reports may point to a series of greater issues within the firm, including:
Client dissatisfaction. A client may not be paying within a timely manner, or even at all, because they are unhappy with the service, dissatisfied with the work product, or have some other grievance.
Poorly written engagement letters. If the language in the engagement letter is unclear, there is a higher possibility of uncertainty in payment deadlines, leading to larger gaps in time before payment is received.
Inefficient billing practices. Firms often send out bills once jobs are complete, rather than periodically. With this practice and a standard turnaround of 45-90 days, the longer a firm waits to bill, the longer it will take for the client to remit payment.
Lax time entry. WIP is often not billed correctly because the work performed is not being captured to its full extent. Moreover, lax time entry can lead to overbilling – exposing the firm to potential client disagreement or even litigation.
Partner performance. While there are many factors that determine partner compensation, clean and up-to-date WIP and AR can play a role. As part of management of a firm, accountability over WIP and AR starts at the top. If the firm’s executives are unable to gain a clear understanding of WIP and AR, partner compensation may be affected. Furthermore, partners may be inclined to leave aged WIP and AR in the system to avoid a write-off, due to fear of poor realization. Aging WIP and AR may be just as strong a factor in determining partner success and productivity.
There are several approaches to help remediate a firm’s problems associated with WIP and AR. These approaches include:
Implementing a retainer or on-account billing. Some firms will collect a retainer to maintain cash flow, which can then be applied to WIP as costs are incurred. If clients are not comfortable with remitting a retainer, a portion of the total bill can be billed out on-account, with the remaining balance payable upon completion.
Discuss billing issues upfront. If there is an agreed-upon courtesy discount (say 20%), billing may be expedited if the discount amount were agreed upon upfront, rather than having been negotiated with the client while the matter is active or completed, and then getting approval from the managing partner. This allows the bill to reach the client sooner and potentially be paid more swiftly.
Call with the client. While never the primary reason for a phone conversation, if a client call does take place, it may be a good time to give notice that a bill has been sent, and that a quick turnaround on payment would be appreciated.
Bill based on client cash flow. With certain clients operating as seasonal-based income businesses, there are times throughout the year when cash flow is slower. Aligning billing with clients’ key seasons/times throughout the year may help assure that bills are paid faster.
Write off uncollectible accounts ASAP. Fear of writing off uncollectible accounts so as not to appear to have poor realization may cause a firm to sometimes write off up to 80% of the WIP against the bill. In reality, all of it should be written off. While realization rates need to be analyzed, it is vital to a firm to clean up WIP and AR, to best avoid the issues mentioned earlier. This measure can be achieved through establishing a tone throughout the firm, that highlights the importance of committing to writing off uncollectible accounts.
Regular review of WIP and AR. Managing partners, executive directors, and C-suite officers should maintain a regular routine of reviewing WIP and AR. This will enable management to stay on top of potential issues before they become a realized problem, which is crucial to maintaining control of WIP and AR and understanding the greater issues that may arise if not reviewed regularly.
Diligence is key to managing WIP and AR reports. While not always a firm’s priority, maintaining healthy WIP and AR may help mitigate billing problems and improve overall cash flow.
If you have any questions about how to maintain a healthy WIP and AR, don’t hesitate to contact Jonathan San Solo at 212.331.7617 | JSanSolo@berdonllp.com, or your Berdon advisor.
Berdon LLP, New York Accountants