Financial forecasting; pie in the sky or a useful tool for gaining a bigger slice of profit?

Whether you are preparing a business plan for your ABS application or simply attempting to gain some idea of your income and expenditure over the next couple of years, you’ll need to get involved in financial forecasting. Generally most firms will base their future expenditure on what’s gone on before tweaked here and there for say rent increases or large capital projects, which if you stick to the plan can prove reasonably accurate.  When it comes to forecasting fee income things generally become more imaginative, with hope sometimes overshadowing realism.  Add to this the disconnect between setting a fee earner on a matter and that turning into a bill, and eventually into cash in the practice’s bank account, and your financial forecast can look like it was written by someone with no knowledge of your business or reality in general.

This needn’t be the case, by focusing on the flow of work as a process, it becomes possible to more accurately determine when time recorded becomes bills and bills become cash. In fact by looking at drivers within the process it also becomes possible to tackle the deadly “lock up.” 

So let’s look at four drivers which will affect your income stream.

Recovery rates; how much of the time recorded by fee earners is actually billed? Is it possible to get the fee earners to work more efficiently and turn more of that time into bills or should this area of the business be given less marketing spend and more emphasis be placed on more profitable areas?

Charge out rates:  this is the basic price you charge your clients and it interacts heavily with the recovery rate. It’s one thing having a charge out rate of £250 per hour, but if your recovery rate is only 50% you’re only ever going to get back £125 per hour. It’s also one of the most difficult to change realistically as you will be doing more harm than good if you increase it above that of your competitors without your client base perceiving any additional value.

Chargeable hours: how many billable hours can you get out of a fee earner? Can you get additional billable hours out of your fee earners each week which will eventually turn into fee income.

Work in progress and debtor days: how long from starting a matter to raising a bill? And how long does it take to collect the cash from that bill? This is a key area as it this time lag which the firm will have to finance, and if not handled well can have a disastrous effect on your liquidity.

By coming up with realistic figures for each of these drivers, for each of your types of work, such as conveyancing, commercial litigation, clinical negligence, it’s possible to incorporate them into your forecasting to determine more accurately your level of fee income and when those fees will be delivered. This makes far more sense that simply looking at what happened last year and adding on a percentage increase.  Additionally there will be marked differences between different work types, your conveyancing department will be much quicker at turning fee earners time into cash then your clinical negligence department.  By separating these departments out, you can see which ones are costing the most to finance, and whether that financing is being recouped by way of better recovery rates and fee income.

It’s the interaction between the underlying production drivers within each department which is missing in the traditional model starting with fee income, and can lead forecasts to be seen as irrelevant.  All of the information required to determine the production drivers will be easily available from your accounting system and it’s more than likely that you use some of them as KPI’s already,  so it makes sense to incorporate them into your business plan.

The beauty of forecasting from this perspective is that you can run scenarios easily which will allow you to change one of the variables to see what effect it will have on the business overall. What happens if you can get an extra half an hour out of each fee earner a day? Would an increase in the recovery rate of 5% be worth pursuing?

So now by focusing on the underlying factors which drive production you can, not just come up with a realistic financial forecast, you can manipulate it to find out what areas of the business  will yield the greatest benefits.  In short it can aid your strategic thinking.

Armstrong Watson can help you prepare your forecasts with or without the above mentioned workflow and work in progress considerations. It’s easier without but will yield better results with.

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