There are a couple of hidden black holes on your balance sheet and income statement that can be the difference between a comfortable cash flow and a challenge with cash flow. Client advances and reimbursed client expenses are two areas that often get overlooked as a threat against cash flow as they are eventually going [...]
There are a couple of hidden black holes on your balance sheet and income statement that can be the difference between a comfortable cash flow and a challenge with cash flow. Client advances and reimbursed client expenses are two areas that often get overlooked as a threat against cash flow as they are eventually going to be reimbursed by a client, at least most of the time. Unfortunately, some law firms, while they may print a monthly financial statement, don’t pay attention to the numbers until there is a quarterly disbursement to the shareholders, or at the end of the year when prepping for taxes.
The IRS provided a ruling over 20 years ago that stated client expenses paid on behalf of the law firm is essentially a client advance or loan to the client until they pay it, and therefore is not expensed by the law firm but must be presented on the balance sheet. However, I’ve seen law firm’s expense client costs when they are incurred, but they typically are billing often and the expenses are reimbursed by the client. This means that it shows up on their Income Statement and offsets their revenue. However, at year end, your accountant will likely ask you to provide how many expenses you’ve paid that the client still owes you. This is so they can reclassify the balance onto your balance sheet.
It is easy for firms to ignore this number because after all, these will get reimbursed. But in actuality, many firms don’t bill monthly, sometimes they bill bi-monthly, quarterly, semi-annually, or at the end of a case. This type of a delay in billing can impact the amount of cash the firm is using to advance clients. How much time lapses between paying for a client cost, let’s say a filing fee or an expert witness fee to when you actually bill it and then get paid. Even if you bill on a monthly basis, it could take you 90 days from the day you pay the cost to get reimbursed by your client.
Here are three best practices to consider regarding client advances:
- If you have a client who is going to require a lot out-of-pocket costs, ask for trust funds that can used to offset these disbursements.
- When getting a partial payment from a client, consider paying off client advances first then apply the remaining payment to fees. You are not paying tax on client advances, you are on fees. And that is money owed to the firm.
- Pay attention and look at the client advances each and every month, preferably before you bill. Look at what you’ve paid out in total, how much of it is sitting in work in progress vs. how much is sitting in accounts receivable.
Find the culprits in the firm who authorize large client advances by running reports by responsible attorney that report client advances by client. It adds up quickly. Just sharing the number with other responsible attorneys can be eye opening, especially when looking at how it impacts your law firm’s monthly cash flow.